Climate scenarios need to be overhauled, IMF says

December 6, 2023|Written by

Climate scenarios used by central banks and financial institutions are outdated and do not take into account recent setbacks from geopolitical events, the International Monetary Fund (IMF) said.

In a staff research note, the IMF said a rush by governments to secure fossil fuel after Russia’s invasion of Ukraine in 2022 led to a “carbon lock-in” while a focus on post-Covid-19 recovery led to countries reducing their focus on reducing emissions. Meanwhile, renewable energy faces headwinds from higher capital costs and mineral scarcity, while a spike in public debt could cause a reduction in low-carbon projects.

All these factors have combined to make the possibility of a disorderly low-carbon transition more likely, something that many climate scenarios do not consider, the IMF note said.

“While the climate scenarios currently used in climate risk analyses already include the possibility of a ‘disorderly’ transition, the short- and long-term implications of the current state of things have not been fully incorporated,” it said.

Regulators and industry bodies like the Network for Greening the Financial System (NGFS) should consider designing scenarios that better fit the current situation and ensure that the joint impact of different shocks are modeled accurately, the IMF said. Results from the latest NGFS analysis show that all models “significantly underestimate coal power capacity expansion since 2020”.

The staff note included a few suggestions for the NGFS on how it could fix its long-term and short-term scenarios to be more accurate, namely by:

  • recalibrating emissions from 2020 to 2023 to take into account Covid-19 and the rebound in emissions rebound afterwards;
  • adjusting fossil fuel consumption to take into account countries’ response to Russia’s invasion of Ukraine;
  • accounting for new investments in coal, gas, and nuclear power plants;
  • depicting changes in energy trade relationships including developed energy infrastructure and;
  • updating energy prices to reflect the trend of rising energy prices.

Climate scientists have been warning financial institutions and regulators that the models they use do not accurately capture climate risks. A recent panel of experts in an event hosted by Green Central Banking and the Climate Safe Lending Network noted that a paradigm shift is needed in economic modeling to effectively assess and manage climate risks to the financial sector. Climate researcher and University of Exeter professor Tim Lenton has argued that central banks and scientists need to collaborate on risk models to make sure the data and methodology are accurate.

This page was last updated December 6, 2023

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