Have you ever wondered how climate risk affects the financial sector? How do you even measure and price it, how do you forecast it? Such questions have been asked by a number of financial institutions, as well as their supervisors. Out of the need to provide reliable and comparable data, the initiative was born Network for Greening Financia Sector(Network for Greening the Financial Sector – NGFS for short).

NGFS – beginnings

The idea of founding NGFS was conceived in 2017. After the signing of the Paris Agreement, it became clear that the financial sector has a huge role to play in transforming the economy to a sustainable and climate-neutral one. The OECD estimates that achieving the goals will consume 6.35 trillion euros a year . Thus, it is not possible to reach zero-carbon just with the help of capital from governments and international institutions. Private capital, i.e. that belonging to companies and non-public financial institutions, must also be mobilized.

It is worth highlighting to banks the risks associated with the energy transition, both in the form of physical and transition risks. In addition, financial institutions should start looking at climate risk not only in the short term, but also up to 2050. After all, many financings or hedges will be in the bank’s portfolio, even in the long term, in a changing environmental and regulatory environment.

In response to these challenges, 8 central banks and financial supervisors recognized the need to jointly solve problems related to the availability of models and data on the transformation of climate risk into financial risk. This is how the NGFS was created, with the main goal of providing the financial market with knowledge and information to strengthen the development of green products. Currently, NGFS has 138 members and 21 observers from 5 continents. Poland is represented by the Financial Supervision Commission. Interestingly, the National Bank of Poland is not a member of this initiative.

Data provided by NGFS

The knowledge provided by NGFS has different dimensions. It concerns both good market practices and models for climate risk. All data is available to the public and free of charge. You have to log in to one of the portals (an account is created free of charge and practically on the spot), but viewing the data is also possible from the guest level. NGFS collects information on published climate risk models from around the world. The initiative also publishes its publications in the form of regular thematic papers.

The most important achievement of the NGFS, however, is the development of models that describe climate risk and its impact on micro and macroeconomic factors under different scenarios. These models are based on the work of the IPCC and the NiGEM macroeconomic model.

NGFS climate models

The climate models developed by NGFS play a key role in analyzing and predicting the impact of climate change on the global economy and the financial sector. They serve as a tool to better understand what effects the adoption or lack of adoption of climate action may have on the economy.

NGFS climate models are simulation tools that can forecast future climate conditions and their potential impact on various sectors of the economy. The development of these models required close collaboration between economists, climate scientists and financial risk specialists. Unlike typical climate models, which focus on forecasting the magnitude of changes in climate elements, NGFS models aim to predict how climate change and climate policy will affect national economies, financial markets and institutions.

Given the uncertain nature of the future, NGFS has developed a set of different climate scenarios to forecast a range of possible development paths, depending on the actions taken (or not taken) on climate policy and technological development. These scenarios are intended to be a key element in the decision-making process of governments, corporations and financial institutions. The models take into account both climate transition risk and physical risk.

NGFS climate scenarios

The NGFS models are divided into four main scenarios, which differ in the scope of actions taken to protect the climate and their effects. They are:

1 Orderly Transition scenario

This is the most optimistic scenario. It assumes that rapid and organized action is taken to protect the climate, in line with the goals set by the Paris Agreement. Under this scenario, effective policies are implemented to reduce greenhouse gas emissions and shift to sustainable energy sources. The result is a gradual, controlled reduction in climate risks, and the economy has time to adjust to the new realities. Economic growth is stable and risks associated with sudden changes are minimized. This scenario offers the best chance of achieving climate goals while maintaining financial stability. It involves quite high costs, but the physical risks are the lowest. This means that we will suffer little from climate change, but we need to invest in rapid global decarbonization.

2. disorderly transition scenario

In this scenario, climate action is taken, but with a delay and is uncoordinated. The result is greater economic uncertainty and higher adaptation costs, as the economy does not have enough time to adjust to new regulations and requirements. Climate-related risks are more difficult to manage, which can lead to serious disruptions in financial markets.

An example is the sudden introduction of strict regulations in response to rapid climate change, which forces costly and rapid changes in sectors such as energy and transportation. This assumes achievement of the Paris Agreement goals. This is a scenario in which transition costs are borne with some time lag, and physical risks are more severe than in an orderly transition scenario. A model covering the current state of climate action implementation, the so-called “Current Policies,” is found here. Current Policies.

3. hot house scenario

This is a scenario that assumes failure to achieve the goals of the Paris Agreement. The measures taken are insufficient to effectively combat climate change. As a result, it is progressing uncontrollably and leading to drastic consequences for the economy and society. Rising temperatures are causing an increase in natural disasters such as floods, droughts and hurricanes. These events have a devastating impact on GDP, causing huge property losses and destabilizing the financial system. The risks associated with this scenario are difficult to predict and manage, leading to significant turbulence in the markets and a decline in investor confidence. The transition costs in this scenario are quite low, but the physical risks generate huge losses.

4. scenario Too little, too late (Too little, too late)

This is the most pessimistic NGFS scenario. By 2023. did not include any model describing it, as it seemed improbable. A model for this scenario is now available, assuming spatially differentiated exposure to the effects of climate change, leading to destabilization and fragmentation of the world as we know it. It is characterized by unevenly borne transition costs and losses from natural disasters.

Importance of NGFS climate models

NGFS climate models are not only a forecasting tool, but also an important educational and strategic component. They provide an understanding of what the long-term effects of actions or inactions in the area of climate policy might be. They help governments, corporations and financial institutions prepare for various possible future scenarios, enabling better risk management. They provide hard numbers on GDP,CO2 prices, energy prices, and the value of individual sectors by country through 2100.

With growing awareness of climate change and its impact on the economy, tools such as NGFS models are becoming an indispensable part of strategic planning. Banks are using data from the models to assess financial stability under different climate conditions and to design policies to minimize climate-related risks.

NGFS models are not without their drawbacks, such as inadequate adaptation to local specifics or high levels of data aggregation for sectors. Forecasting the future today is fraught with a high degree of uncertainty, and the volatility of climate and climate policy makes it difficult to predict all possible impacts. Therefore, NGFS is constantly updating its scenarios to incorporate the latest data and changes in climate policy.

The financial sector faces a huge challenge in financing the transformation of the economy towards sustainability. NGFS models help understand the risks associated with the pace of achieving zero-carbon and climate change. While the available models are imperfect, they definitely help illustrate the scale and costs associated with different scenarios of our future. They can provide greater awareness and stability to the financial sector.

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