Calipel, C., Fidel, L. (2023): Climate stress tests: what co-benefits can we expect for transition financing? An ex-post analysis.  National Case Study of the 4i-TRACTION Deliverable D2.6. I4CE. Berlin

Climate Stress Tests: What Co-Benefits can we Expect for Transition Financing?

This case study identify analyses possible co-benefits that climate stress tests may have on transition financing, as well as their limits in this regard.

Since their introduction, climate stress tests have taken a lot of space in the public debate. Put in the spotlight by supervisors and the Network for Greening the Financial System, their primary objective is to encourage banks to integrate climate-related risks into their activities and to carry out an initial assessment of the banks' capacity to deal with these risks.

The public debate around climate stress testing has quickly focused on the methodological difficulties of developing a framework for analysing climate-related risks or developing appropriate transition scenarios. The case study seeks to move away from this focus by looking at another aspect. Beyond their contribution in terms of assessing the exposure of financial institutions to climate-related risks, and although this is not their initial objective, climate stress tests could in fact also have indirect impacts on transition financing.

In its case study, I4CE attempts to identify what possible co-benefits climate stress tests may have on transition financing, as well as their limits in this regard. The findings presented are based on an ex-post analysis of the initial lessons learned by French banks and supervisors from these exercises. The impact of climate stress tests is examined throughout their process, from the operational processes of their implementation to the impact they may have on banks' strategic thinking and decision-making concerning transition financing.

The most significant impact climate stress tests may have on transition financing come from their capacity to mobilise a large portion of banks' internal teams and supervisors around climate-related issues. The successive climate stress tests implemented by the supervisors on French banks have been very useful in enabling an initial integration of climate issues into the banks' organisational processes and governance. The more the banking teams are trained and coordinated on climate issues, the more they could potentially be in a position to take decisions in favour of financing the transition. However, this will depend on whether banks can identify financial opportunities or whether regulatory requirements provide incentives.

However, climate stress tests enabled a fragmented analysis of climate-related issues, moderating or limiting the co-benefits of these exercises on transition financing. Environmental Performance Certificates are essential for banks to participate in the financing of the transition in the real estate sector, but greenhouse gas emissions data on banks' largest counterparties do not help banks to better finance the transition, as they do not provide sufficient insights into the transition potential or financing needs related to the implementation of the counterparty transition plan.

The analyses deriving from the modelling exercises also had a limited impact on the ability of banks to finance the transition. They presented numerous difficulties in assessing the impact of the transition in the real economy, and they did not manage to sufficiently grasp the dynamics of the transition and the various risk transmission channels. Yet, for banks to be able to participate in the financing of the transition, it seems very important that they have fully integrated all the specificities of these dynamics, in order to take decisions accordingly.

As a result, climate stress tests have globally played a limited role in transition financing. The lack of reliability given to climate stress tests methodologies prevent banks from incorporating the stress tests results into their decision-making processes.

The results of the study show that it seems unlikely that climate stress tests will ever succeed on their own in triggering a big shift in transition financing. To achieve this objective, climate stress tests should be accompanied by other instruments that allow banks to better understand the transition dynamics of their counterparties in order to better support them in the transition. Banking transition plans could be an effective solution for that, since they should rely on banks' counterparties transition plans, and allow the banks to better understand how they can accompany their counterparties in the transition. They could then have a significant role in filling in the missing pieces needed to put banks in a position to provide transition financing and thereby play an active part in the quest for an orderly transition.


Download the case study here.

Read more about the overview report here.