Central banks require commercial banks to conduct specialized Climate Risk Stress Tests to evaluate their resilience to extreme transition and physical shocks.
The Climate Stress Testing Pipeline
- Scenario Parameter Mapping: Applying specific NGFS parameters (such as a sudden, steep carbon tax increase or a severe regional flood event) to bank asset models.
- Credit Loss Projection: Modeling the impact of the scenario on corporate default rates, collateral valuations, and risk-weighted assets across carbon-sensitive and geographically exposed sectors.
- Capital Adequacy Evaluation: Calculating post-stress capital ratios to ensure the banking system maintains sufficient loss-absorbing capacity to survive severe environmental adjustments.