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Banks explore climate risk resilience in Federal Reserve pilot study

Written on May 21, 2024

The Federal Reserve Board has released a summary of an exploratory pilot Climate Scenario Analysis (CSA) exercise conducted with six major U.S. banks. 

The summary outlines how these banks used climate scenario analysis to assess the resilience of their business models against climate-related financial risks. The participating banks employed various approaches to consider the potential implications of different physical and transition risk scenarios, revealing data gaps and modeling challenges associated with estimating the financial impacts of complex and uncertain risks over different timeframes.  

The six banks involved in the exercise were Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley and Wells Fargo. The pilot exercise was exploratory in nature and did not result in capital consequences. 

Key insights from the exercise include:  

  • Participants used climate scenario analysis to evaluate the resilience of their business models across short- and long-term time horizons.  

  • Different approaches were taken by participants to construct detailed physical and transition risk scenarios, driven by factors such as business models, risk perspectives, data accessibility and prior experience with climate scenario analysis.  

  • Most participants relied on existing credit risk models to estimate the impact of climate risks on their portfolios, assuming continuity in historical relationships between model inputs and outputs.  

  • Significant data and modelling challenges were reported by participants, including issues related to comprehensive and consistent data availability, leading many to rely on external vendors to fill gaps.  

  • Understanding and monitoring indirect impacts and chronic risks were highlighted as crucial for managing climate-related financial risks.  

  • The role of insurance in mitigating climate change risks for consumers, businesses and banks was emphasized, with a call to monitor changes in insurance costs and their impacts on specific markets and segments.  

  • Design choices significantly influenced insights drawn from the exercise, including shock scope, scenario severity, starting points, insurance assumptions and balance sheet assumptions.  

  • Participants expressed the high uncertainty and difficulty in measuring climate-related risks, making it challenging to incorporate them into risk management frameworks on a routine basis.  

  • While not the primary focus, participants' estimates of climate-adjusted credit risk parameters showed notable variations across sectors, regions and counterparties.  

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