The heat is on: A framework for measuring financial stress under disruptive energy transition scenarios

Abstract

This paper introduces a stress test framework designed to quantify financial stability risks related to the energy transition. As is standard in financial stress testing, we first construct various tail-event scenarios, in which we incorporate shocks to climate policy and energy technology. We then use various modeling approaches to derive macroeconomic and industry-specific implications of these shocks. To illustrate the framework, we use granular data on EUR 2.3 trillion in assets of more than 80 Dutch financial institutions. We find that financial losses due to credit and market risk could be sizeable. For instance, portfolios values can decline by up to 11%. Such magnitudes suggest that climate-transition risks warrant close attention from a financial stability perspective, while also underlining the importance of avoiding transitions that would be too late and too sudden.