Uncertainty Is Not an Excuse. Integrating Climate Risks into Monetary Policy Operations and Financial Supervision

This policy brief from the SUERF association summarises the results of an analysis of climate-related transition risk metrics in a sample of firms from the European Central Bank’s (ECB’s) corporate bond portfolio. The research ranked the assessments of 12 transition risk metric providers for 287 companies owned by the ECB as of August, 2020, finding that current climate risk metrics can and should be used by central banks and financial supervisors to account for climate risks in monetary policy operations and financial supervision.

Growing numbers of central banks and financial supervisors are exploring metrics to use to capture climate risks, and to what extent different metrics and scenarios deliver different results for the same firms. Against this background, this study finds that different methodologies, modelling assumptions and data sources lead to a diversity of climate risk metrics, with risk assessments converging towards the extremes of those firms most exposed to climate transition risks, and those least exposed.

The study also examines the possible reasons behind this divergence in assessments across metrics. Cluster analysis shows three pronounced differences in methodologies used across the providers examined: aggregated exposure indicators, estimation of specific financial indicators, and a ‘catch all’ category of metrics not based on a forward-looking or firm-level analysis.

The specific characteristics of the methodologies underpinning risk metrics are also important, the authors find. For example, different temperature targets and time horizons can change the relative assessment of a company’s exposure to transition risks. It is therefore extremely important that users of climate risk assessments understand the assumptions and methodologies that underpin the metrics they use.

Emphasising that “diversity in climate risk assessments is a feature, not a bug,” the paper concludes that central banks and financial supervisors should not wait for further convergence between risk metrics before starting to use them. However central banks and financial supervisors should use a range of risk metrics to get a more complete picture of their exposure to climate risks, rather than relying on one or two.

The policy brief ends with a quotation from Bank of England Governor Andrew Bailey: “uncertainty and lack of data is not an excuse.”

Related research from the Council on Economic Policies was the first to examine how climate-related transition risks are assessed across different providers of risk metrics, finding that climate risk assessments of individual companies across metrics is diverse, but with more agreement on companies most and least exposed to transition risks.