NGFS issues short-term scenarios to inform climate risk assessments of banks

The financial world often grapples with long-term horizons when it comes to climate change, envisioning shifts decades in the future. However, the recent publication of the first set of short-term climate risk scenarios by the Network for Greening the Financial System (NGFS) brings the immediate and tangible impacts of climate change and climate policies into sharp focus. This development indicates that banks could re-evaluate how they assess and manage risk in their day-to-day operations and strategic planning.

Why short-term scenarios matter now

While long-term climate scenarios (2050+) guide strategic planning, they often miss immediate, disruptive threats within a typical 3-5 year business cycle. The recently published short-term scenarios from NGFS close this crucial "horizon gap." They capture acute physical risks from extreme weather and abrupt transition risks from sudden policy shifts or market repricing. Crucially, they also model how these climate shocks interact with economic cycles, amplifying impacts. This near-term focus is vital for effective stress testing, capital planning, and portfolio management, enabling banks to proactively manage immediate vulnerabilities.

Key scenarios and their implications

The NGFS has introduced four distinct scenarios in this first iteration, each designed to illuminate different facets of near-term climate risk:

• The "Disasters and Policy Stagnation" scenario focuses on physical risks, assuming severe regional extreme weather events without significant new climate policies. This implies direct economic disruption with significant regional GDP losses (e.g., up to 12.5% for Africa and 6% in Asia), increased inflation due to higher production costs, and deteriorated credit quality for exposed businesses and individuals.

• The "Highway to Paris" scenario envisions an orderly and early implementation of ambitious, gradual climate policies aligned with a net-zero trajectory. While targeting long-term benefits, the near-term still involves sectoral shifts as industries transition, creates new investment opportunities in green technologies, and projects relatively manageable economic impacts, with global GDP losses around 0.4% by 2030.

• The "Sudden Wake-Up Call" scenario depicts a delayed but abrupt implementation of climate policies, leading to a more disorderly and potentially costly transition. This could result in higher economic costs, with global GDP losses reaching 1.3% by 2030 if the transition is delayed by three years, alongside significant market volatility due to asset repricing and potential credit contraction in challenged sectors.

• The "Diverging Realities" scenario combines elements of physical and transition risk, envisioning fragmented climate policies across regions alongside concurrent physical shocks. This scenario highlights acute supply chain vulnerabilities from regional weather events that inflate transition costs, leading to uneven economic impacts across different geographies and sectors, complicating risk assessment for diversified portfolios.

These scenarios are not forecasts but rather plausible pathways designed to help financial institutions explore the potential range of outcomes and build resilience. They offer impressive sectoral and geographical granularity, making them particularly useful for climate stress-testing exercises.

Timelines and next steps

The NGFS has emphasized that these are the first iteration of short-term scenarios, signaling an ongoing commitment to refinement and enhancement. While no specific future release dates were specified, the historical approach of NGFS suggests regular updates and improvements to their scenario framework.

For banking institutions, integrating these scenarios into assessments implies concrete actions across their operations and strategy. To effectively navigate this, banks need well-honed capabilities to:

• Quantify risks: Accurately assess the financial impact of physical and transition risks on portfolios, translating climate hazards and policy shifts into credit risk metrics (for example, probability of default and loss given default).

• Conduct advanced stress testing: Simulate outcomes across diverse asset classes for potential capital impact and concentration risk, applying the NGFS short-term scenarios and integrating with long-term views.

• Strengthen enterprise-wide risk management: Embed climate risk into daily enterprise risk management processes, enabling continuous monitoring, early warning signals, and informed decision-making across lending, portfolio management, and treasury functions.

• Leverage granular data: Access and integrate rich datasets (for example, emissions, hazard maps, and geolocation data) to enable highly specific risk assessments at the individual asset or counterparty level.

• Support regulatory compliance and reporting: Facilitate the provision of necessary data, analytics, and reporting capabilities to meet evolving regulatory requirements for climate-related financial disclosures and stress tests.

Embracing these advanced capabilities allows banks to move beyond reactive measures. This enables them to confidently address evolving regulatory demands, unlock opportunities in the green economy, and build a more resilient and sustainable financial future.

Related links

• Press release

• Related publications