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Sita Subramanian

Sita Subramanian

Senior Associate, MSCI Research

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Climate Stress Tests: Upping the Ante for Banks and Insurers

  • The Network for Greening the Financial System, with its third version of climate scenarios, is a landmark reference for central banks and supervisors seeking to understand the climate risk exposures of financial institutions.
  • However, regional divergences in how these climate stress tests are implemented limit their usefulness in assessing and comparing individual institutions’ exposures to climate-related risks.
  • Addressing data gaps on value-chain emissions and climate targets of the institutions’ customers will be critical to maximizing the value of climate stress test results for supervisors and investors.

When institutional investors and financial supervisors seek to understand climate risk exposures of banks and insurers, they look to climate scenario analysis. In particular, many central banks and supervisors look to the Network for Greening the Financial System (NGFS) to develop a harmonized system for climate scenario analysis. At least 31 central banks and supervisors have completed, are conducting or are planning bottom-up or top-down climate scenario analysis exercises, with a minimum of 22 leveraging the baseline NGFS Reference Scenarios.1 NGFS has recently published the third version of these scenarios, which encourage comparability of results across borders and are useful for investors and supervisors alike.

The problem, however, is that these stress tests are inconsistently applied across regions, potentially limiting the value of their results. Over time, addressing gaps in data on value-chain emissions and climate targets of financial institutions’ customers will be critical to making these analyses more useful.


Different approaches to climate stress testing

One major difference is how supervisors view the balance sheets of financial services companies. Balance-sheet assumptions remain important, providing investors with insight into the possible strategic investments and divestments a financial institution may make to adjust its exposure to climate-related risks. The Bank of England (BoE), Bank of Canada (BoC) and Hong Kong Monetary Authority (HKMA) assumed a static balance sheet, under which the size, composition and risk profile does not vary over the stress testing time horizon. But several other jurisdictions have used a hybrid approach, assuming a dynamic balance sheet for certain, long-term horizons.

Another difference is the type of climate risk supervisors have assessed in their climate stress tests. The BoC has focused on testing for transition risks,2 while the European Central Bank (ECB), BoE, Autorité de Contrôle Prudentiel et de Resolution (ACPR), HKMA and Australian Prudential Regulation Authority (APRA) focused on both transition and physical risks (see exhibit below). These differences may hamper investors’ ability to compare the full suite of climate-related risks faced by all institutions.


Key features of climate stress testing programs — a global comparison

This table shows how different supervisors take different approaches in evaluating climate stress tests. These approaches impose varying requirements on financial institutions and limit the value of comparisons for investors.

“Financial risk types covered" refers to the types of exposures participants were asked to consider through either quantitative projections or qualitative questionnaires.

Sources: MSCI ESG Research LLC and ECB, BoE, ACPR, BoC, HKMA, APRA, as of Sept. 12, 2022.


NGFS scenarios serve as a common baseline, but divergences exist

Another key difference is that some financial supervisors changed the timeframes over which risks are projected to materialize and implemented region-specific low-carbon strategies (see exhibit below). While these adjustments may help provide better assessments to local conditions, they also run the risk of complicating an investor’s interpretation of a financial institution’s resilience to plausible climate outcomes.


Differences in assessing climate transition risk globally

Financial supervisors use varying timeframes to measure projected risks and adopt region-specific low-carbon strategies, which may complicate an investor’s interpretation of a financial institution’s resilience to possible climate outcomes.

This exhibit focuses on select jurisdictional overlays representing key divergences from the NGFS scenarios. Notice the difference between the definition of “short term” between the various supervisors: e.g., the ECB defines short term as three years, while the HKMA and ACPR defines it as five years.

Sources: MSCI ESG Research LLC and ECB, BoE, ACPR, BoC, HKMA, APRA, as of Sept. 12, 2022.


Looking ahead

The NGFS has noted that while alignment with its reference scenarios is desirable, systemic limitations, including linking NGFS scenarios with domestic macroeconomic models, make consistency among supervisors difficult.3

While these problems are significant, the elephant in the room is the lack of available data for many financial institutions.4 Financial supervisors have noted that data gaps in emissions and climate targets of insurance and bank-loan-associated counterparties have curbed meaningful and comparable results across institutions and markets. Only 34% of constituents of the MSCI ACWI Investable Market Index (IMI) reported some type of climate target data and only 14% reported progress against those targets, as of Aug. 31, 2022

Regulators also have noted that financial institutions will need to fill data gaps for value-chain emissions (Scope 3) to obtain better estimates of portfolio climate risks and to evaluate counterparties through the low-carbon transition. Though the materiality of Scope 3 emissions will need to be determined, disclosure of Scope 3 greenhouse gas emissions in the MSCI ACWI IMI is currently limited, with only 27% of constitutents currently disclosing one or more of the 15 categories forming Scope 3 (see exhibit below).


Status of emissions disclosures for MSCI ACWI IMI constituents

This exhibit shows the extent to which different sectors disclose Scope 1+2 and Scope 3 emissions. Only 27% of MSCI ACWI IMI constituents currently disclose one or more of the 15 categories of Scope 3 (value chain) emissions.

Source: MSCI ESG Research LLC, as of Aug. 31, 2022.

However, it’s still early days for climate stress tests for financial institutions. Though regional divergences are expected to persist, the practice may lead to more climate-related information and empower more informative results for investors as financial regulators increasingly mandate these exercises.



1“Scenarios in Action: A progress report on global supervisory and central bank climate scenario exercises.” NGFS, Oct. 19, 2021.

2Transition risks include those related to the process of adjustment to a low-carbon economy, e.g., changes in policy, technology, market and consumer sentiment.

3“Scenarios in Action: A progress report on global supervisory and central bank climate scenario exercises.” NGFS, Oct. 19, 2021.

4Verbraken, Thomas, and Szikszai, Monika, “Measuring Climate Impact with Total-Portfolio Carbon Footprinting.” MSCI Blog, July 18, 2022.



Further Reading

Implementing Net-Zero: A Guide for Asset Owners

Measuring the Path to Net-Zero

TCFD-Aligned Climate Risk Reporting

Climate and Net-Zero Solutions

The MSCI Net-Zero Tracker