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By Clemens Wieck | Jan Schneider | Uwe Dahlmeier

Many banks in Germany and Europe have greatly advanced the development and analysis of climate scenarios as part of capital planning and stress tests in recent years. These are usually based on scenarios from the Network for Greening the Financial System (NGFS) or the International Energy Agency (IEA). However, with a growing understanding of the impact channels of climate risks, it is becoming apparent that short-term and disruptive effects in particular are not adequately reflected in such scenarios, which makes it difficult to integrate the corresponding risk drivers into banks’ capital planning and adverse scenarios of the ICAAP. Advanced institutions are currently working on innovative solutions based on NGFS or alternative model approaches from which the market can learn on a broad scale in order to strengthen the integration of climate risks into bank management.

Risks associated with climate change have become increasingly important in the financial sector. The effects of both climate change and the transition to a low-carbon economy are already manifesting themselves today and may intensify further. However, short-term risks in particular, which are driven by possible disruptive developments over the next three to five years, have so far been insufficiently mapped and taken into account. The integration of consistent short-term scenarios into management elements such as the normative ICAAP could show that the risks and opportunities associated with the transition are significantly greater than previous approaches suggest and is therefore indispensable as an element of forward-looking risk management.

“If the only tool you have is a hammer” – long-term scenarios and optimal paths

A global market study by KPMG 1 shows that in 2023 more than 90% of the banks surveyed are actively working on climate risk stress tests, with the climate scenarios of the NGFS 2 or slightly adapted variants are used by more than 70% of the banks. The ECB also relied on NGFS in the 2022 climate stress test. However, compared with other adverse macro scenarios, e.g. from the EBA stress test, it is clear that the scenarios based on NGFS only result in mild stress for the economy as a whole.

NGFS offers long-term scenarios with a horizon up to 2100 that describe the transition on the basis of socio-economic narratives. The linear models used to quantify the scenarios simulate minimum-cost paths for the development of the energy system. Important drivers of short-term risks are not mapped in this framework – in particular the possibility of disruptive developments, i.e. a short-term divergence between market expectations and actual developments, increasing volatility and non-linear dynamics. NGFS is already responding to this deficit and has presented a concept paper that emphasizes the need for specific short-term scenarios and alternative model approaches. The paper develops five narratives for short-term scenarios, which are quantified in the next step3. The new scenarios are an important step, but reveal a still too narrow understanding of transition risks as fluctuations around long-term paths with a strong focus on CO2 prices.


Comprehensive, leading scientific analyses show a characteristic, empirically based course of technology transitions. At the beginning, the development of new technologies is exponential, driven by progress in science and manufacturing as well as the size of the market, up to a market coverage of ~50%. Only then does the development become linear, converging towards the market at the end.
This behavior also provides expected values for the energy transition in the model of Dr. Dahlmeier Financial Risk Management AG, based on an approach developed at the University of Oxford, see Fig. 01. According to this model, the exponential development will probably continue until 2034. Renewable energies (RE) will cover global electricity demand by then, even taking into account the additional demand from e-mobility and heat pumps. In addition, this change will be accompanied by high efficiency gains from the replacement of traditional technologies, so that primary energy demand will decline until around 2033 without any additional shortage of available final energy.


Risk drivers politics, consumption, technology – more than CO2 prices

A large number of instruments are used in climate policy whose economic impact cannot be represented by carbon prices – but which should nevertheless be reflected in banks’ risk management. In addition to emissions trading, the EU relies on the direct promotion of renewable energies and energy efficiency. In addition, the introduction of tariffs on the carbon content of certain goods was decided with the Carbon Border Adjustment Mechanism (CBAM). The US government has dispensed with CO2 prices and is relying on massive subsidies for renewable energies and public investment with the Inflation Reduction Act.

Another important dimension is the interaction of the transition with other risk drivers. For example, new critical supply chains are emerging, resulting in a significant shift in geopolitical interests. On the supply side of fossil fuels, the risks of already volatile markets are exacerbated. New tensions arise in trade policy – e.g. via the EU’s CBAM4tariffs on steel5 and e-cars6 – which could escalate into trade conflicts. Physical risks and risks associated with the transition are also interrelated. For example, a drought in China is causing a decline in hydroelectricity and driving up energy prices, with a corresponding impact on production and supply chains7 [7].

Changes in consumer behavior also have disruptive potential, as market shares of low-carbon manufactured goods can increase, even if production costs are not yet competitive. This can be observed in the area of e-mobility and “green” steel.

Technological progress is key, not only for the speed of the transition, but also for its economic impact – on energy prices, supply chains and competitiveness. Box 1 describes and quantifies an alternative scenario of technological development in the energy sector. Examples such as these show that alternative solutions already exist today and can be further analyzed by banks and integrated into bank management tools.

Conclusion and outlook

Currently available NGFS scenarios are not conceptually suitable for an appropriate assessment of short-term climate risks that exist due to the possibility of disruptive developments in politics, technology and consumer behavior. In particular, the strong focus on CO2 price developments neglects important risk drivers, such as an accelerated transition driven by falling costs.

Banks face the challenge of developing an effective framework for identifying and assessing short-term climate risks. Institutions can now approach this in three steps:

1. Identification of short-term impact channels to which they are potentially materially exposed – e.g. structured by portfolios, sectors and regions.

2.  Strengthening the framework for sensitivity analyses in order to quantify the impact channels and their effect on material risk types – including the short-term, disruptive effects described in this article.

3. Integration of the key sensitivities into the scenario framework, e.g. by combining the effects described in Box 1 and other relevant narratives with macroeconomic scenarios, in order to be able to take realistic effects of the transition into account in business and capital planning.

The examples presented in this article demonstrate that such approaches already exist today and can be used by banks.

  1. KPMG AG Wirtschaftsprüfungsgesellschaft, “ESG in Practice: Results from the Global Banking Survey,” [Online]. Available: https://kpmg.com/de/de/home/insights/2023/12/esg-risk-management-in-banks.html. [Zugriff am 31 12 2023]. ↩︎
  2. NGFS, “Network for Greening the Financial System,” 4 12 2023. [Online]. Available: www.ngfs.net. [Zugriff am 4 12 2023]. ↩︎
  3. NGFS, “Conceptual note on short-term climate scenarios,” 2023. ↩︎
  4. A. Lv and D. Patton, “China steel association says EU carbon tax a new trade barrier, calls for more talks,” Reuters, November 2023. ↩︎
  5. J. Olk, M. Koch and A. Meiritz, “USA and EU want to further suspend punitive steel tariffs,” Handelsblatt online, October 2023. ↩︎
  6. L. Backovic, S. Gusbeth, M. Fasse, F. Hubik and M. K. and Julian Olk, “EU threatens China with tariffs on e-cars,” Handelsblatt online, September 2023. ↩︎
  7. J. Kemp, “Beset by drought, China turned to coal to keep lights on,” Reuters, July 2023. ↩︎