ClimateStress-testoftheFinancialSystem
StefanoBa*ston,FINEXUSCenterforfinancialnetworksandsustainability,
Dept.ofBankingandFinance,Univ.ofZurich
2
• Networkanalysisofdirectandindirectexposures
• Disclosureofclimate-relevantfinancialinformaFoniskeytoimproveriskesFmaFonsandcreatetherightincenFvesforinvestors.However,beHerdisclosuremaynotbesufficient.
• TheFmingandcredibilityoftheimplementaFonofclimatepoliciesmaHer.• Earlyandstablepolicyframework:smoothcarbon-asset
valuesadjustments• alateandabruptimplementaFon:adversesystemic
consequencesforthefinancialsystem.
Outline
(1)BaSston,S.,Mandel,Antoine,Monasterolo,I.,Schuetze,F.,VisenFn,G.:AClimatestress-testoftheEUfinancialsystem.AvailableSSRNid=2726076.(2016).
ClimateRelevant Sectors
Financial Sectors
Shocks on financial exposures
Shocks on Financial provisions
Climate Policies
Climate Change
Financial Regulation
Systemic risk, inequality
TheSourceofComplexityintheClimate–Financenexus
• DashboardonEuroAreanetwork-basedstress-test
hHps://simpolproject.eu/2016/06/09/debtrank-2/[BaSstonetal2016,Leveragingthenetwork.StaFsFcsandRiskModeling,1–33].
• DashboardClimateStress-testfinancialhHps://simpolproject.eu/2016/06/10/climate-stress-test/[BaSstonetal.2016,AClimatestress-testofthefinancialsystem.AvailableatSSRNid=2726076.].
Dashboards
6
LoanPorgoliosofMajorEuroAreaBanks–Leverageacrosssectors
7
TradiFonalsystemicriskmodelpredictliHlecontagion,becausetwokeyassumpFonsruleoutcontagionbyconstrucFon1. R=1i.e.banksassetscanbeliquidatedatanyFmewithnoloss2. Onlydefaultvalua=on:obligaFon’svalueunaffectedbylosseson
obligor’sequityunlessdefault.Conserva=onconstraintonlossesintheprocess.
ànetworkstructureisirrelevantfortheaggregatelosses.àAlmostnobanks’defaultsajeriniFaldefaults
TheNO-CONTAGIONParadox
InadistresscontagionaccounFngframework,intra-financialcontagionapproximatedbysimpleandinstrucFveformula
H=εs+(1-RE)β ε s=2εswhereHistherelaFveequitylossinthebankingsystem,bistheinterbankleverage,eistheexternalassetleverage,andREistherecoveryrateonexternalassets.
(1)VisenFnetal.2016“RethinkingFinancialContagion”,(2)BaSston,Caldarelli,D’errico,Gurciullo,S.(2016).Leveragingthenetwork.StaFsFcsandRiskModeling,1–33.BaSston,S.,Roukny,T.,SFglitz,J.,Caldarelli,G.&May,R.ThePriceofComplexityinFinancialNetworks.PNAS(2016)www.pnas.org/content/113/36/10031.full
FINEXUSclimatestresstestmethodology² Newframeworkbasedonnetworkanalysistoassessthe
largestexposuresoffinancialactorstoclimatepolicyrisks
² 3keyconceptual/methodologicalinnovaFons:
1. Reclassifica=onofNACERev2sectors2. QuanFficaFonofdirectexposurethroughexternalassets3. Assessmentofindirectexposure,includingintra-financial
interlinkages
DATASETS:• BvdOrbisandBankscope• ECBDataWarehouse• NACEcodedescripFonBa#ston,S.,Mandel,Antoine,Monasterolo,I.,Schuetze,F.,Visen.n,G.:AClimatestress-testofthefinancialsystem.AvailableSSRNid=2726076.(2016).
Banks(MFIs)
Totalassets:31TEquity=A-L:3T
NFC(Non-financialcorporaFons)
Totalassets:21T
HH(Households)
Totalassets:22T
Gov(Government)
Totalassets:5T
OFI(OtherFinancialInsFtuFons)
Totalassets:26.8T
Non-MMFIF(Non-MMF
Investmentfunds)
Totalassets:10.3T
I&PF(Insurance&
Pensionfunds)
Totalassets:9.3T
9%
13%
16%
5%
15%
6%
30%
12%
5%
24%
Equityholdings
Bondholdings
LoansholdingsNB!:NormalizaFonforallactors–bythetotalassets
Someindirectexposuresoffinancialsectorstotherealeconomy
Banks(MFIs)
Totalassets:31TEquity=A-L:3T
NFC(Non-financialcorporaFons)
Totalassets:21T
HH(Households)
Totalassets:22T
Gov(Government)
Totalassets:5T
OFI(OtherFinancial
InsFtuFons)
Totalassets:26.8T
IF(Non-MMF
Investmentfunds)
Totalassets:10.3T I&PF(Insurance&
Pensionfunds)
Totalassets:9.3T
Financialexposures
Macro-economicfeedback
Fossil-fuelextrax/onsector
U/li/es
Energy-intensive
Housing
Transport
Mainchannels:
1.Fossil-Fuel->U/li/es->Transport2.Fossil-Fuel->Transport3.U/li/es->Housing4.U/li/es->Energy-intensive
Reclassifica.onlogic:
1.U/li/es,transport,housing-topsectorsforGHGemissions(scope1)2.Fossil-fuels(lowdirectbuthighindirectemissions)3.Ac/vi/esaffectedbyclimatepolicyeitherthroughcostsorrevenues).
Fossil-fuelsupply
ElectricitysupplyElectricity
supply
Figure1.DiagramillustraFngthereclassificaFonofsectorsfromNACERev2codesintoclimaterelevantsectors.
Methods:iden=fica=onoftheclimatesensi=vesectors
Methods:iden=fica=onofdirect&indirectexposurestothetheclimatesensi=vesectors
Ai =S∈S
∑ αijEquity +αij
Bonds +αijLoans
j∈S
∑⎛
⎝⎜⎜
⎞
⎠⎟⎟+ Ri
Directexposures:throughassetsofthemarketplayer
Ai
AFS = αiS
i∈F
∑αij
-Totalassetsofthefinancialactori
-Monetaryvalueofexposureofitoj
S -Setofclimate-relevantsectors
-ExposureofinsFtuFonFtoagivenclimatesector
Indirectexposures:throughinterlinckagesofthemarketplayerwithitscouterparFes
Ai = αijEquity (Aj )+αij
Bonds (Aj )+αijLoans (Aj )
j∈F
∑⎛
⎝⎜⎜
⎞
⎠⎟⎟+ αik
Equity +αikBonds +αik
Loans
k∈A/F
∑⎛
⎝⎜
⎞
⎠⎟+ Ri
αij0 ⋅α jk
0 -Productofexposuresalongthechain
Methods:iden=fica=onoftheclimatesensi=vesectors
Fossil-fuel
U,li,es
Energy-intensive
Housing
Transport
B
C
D
F
H
NACE2codesClimate-sensi,vesectors
AssetPorBoliobyinstrument
Equity
Bonds
Loans
Reclassifica,onofeconomicsectorsfromNACE2intoclimate-sensi,vesectors
Classifica,onofassetsaccordingtoinstrumentandclimate-sensi,vesectors
AssetPorBoliobyclimatesector
TradiFonal Proposed
Ba#ston,S.,Mandel,Antoine,Monasterolo,I.,Schuetze,F.,Visen.n,G.:AClimatestress-testoftheEUfinancialsystem.AvailableSSRNid=2726076.(2016).
EquityholdingsinEUandUSlistedcompanies.SectorcomposiFonofaggregateinsFtuFonalsectorsworld-wideaccordingtoBvDdata2015.
Results:Exposuretoclimatesensi=vesectors
Ba#ston,S.,Mandel,Antoine,Monasterolo,I.,Schuetze,F.,Visen.n,G.:AClimatestress-testoftheEUfinancialsystem.AvailableSSRNid=2726076.(2016).
PorYoliocomposi=onoftopworld-wideInvestmentFunds:climate-sensi=vesectorsexposure
u Thismicro-levelapproachallowsustounderstandheterogeneityofinvestors’exposureandporgolioallocaFon.
Ba#ston,S.,Mandel,Antoine,Monasterolo,I.,Schuetze,F.,Visen.n,G.:AClimatestress-testoftheEUfinancialsystem.AvailableSSRNid=2726076.(2016).
PorYoliocomposi=onoftopworld-wideBanks:climate-sensi=vesectorsexposure
u Thismicro-levelapproachallowsustounderstandheterogeneityofinvestors’exposureandporgolioallocaFon.
Ba#ston,S.,Mandel,Antoine,Monasterolo,I.,Schuetze,F.,Visen.n,G.:AClimatestress-testoftheEUfinancialsystem.AvailableSSRNid=2726076.(2016).
Rela=veporYoliocomposi=onoftopworld-wideBanks:climate-sensi=vesectorsexposure
Ba#ston,S.,Mandel,Antoine,Monasterolo,I.,Schuetze,F.,Visen.n,G.:AClimatestress-testoftheEUfinancialsystem.AvailableSSRNid=2726076.(2016).
Impactonthetop50listedEUbanksofa100%shockinthemarketcapitalizaFonoftheclimate-sensiFvesectorsindifferent,progressiveaggregaFons.
Exercise1.UpperboundofEuroAreabanks’loss:100%shockonFossil-Fuel+U=li=essector
• EquitylossofEUbanksfromafossil-fuelsectorshockonlyis2.55%,andincreasesto6.08%whenincludingindirecteffects.
• Lossesincreaseto13.18%(directeffect)and27.91%(directandindirecteffect)whenincludinguFliFesandenergy-intensiveindustriesonequityshares(1.2T).
Exercise2.ShocksobtainedfromLIMITSIAMdatabase
Exercise2.ShocksobtainedfromLIMITSIAMdatabase
Firstroundlosses(top)andsecondroundlosses(boHom)ofa“brown”and“green”banks’equity
Exercise2.ShocksobtainedfromLIMITSIAMdatabase
ValueatRisk(5%significance)forthe20mostaffectedEUbanks inthedataset,underthescenarioofg reen (brown) investmentstrategy.Darker colors: VaR(5%) in thedistribuFon of first-round losses.Lighter colors: VaR(5%) in thedistribuFonof first- and second -roundlossestogether.
ClimateRelevant Sectors
Financial Sectors
Shocks on financial exposures
Shocks on Financial provisions
Climate Policies
Climate Change
Financial Regulation
Systemic risk, inequality
TheSourceofComplexityintheClimate–Financenexus
• FinancialinterconnectednessmaHersforfinancialstability
andmacro-prudenFalpolicy.• Inthepresenceofuncertaintyonvalueofassetsbacking
upobligaFons,anduncertaintyondefaultresolu=onprocess,directlossesfromshockscanbedoubled,duetoindirectlossesviaintra-financialcomplexity1.
• Further,inaccuracyonpriceof(systemic)riskincreaseswithcomplexity2.
• CollecFvemoralhazard:thefinancialsystemdoesnotpayforthe
Conclusion
(1)BaSston,S.,Puliga,M.,Kaushik,R.,Tasca,P.,&Caldarelli,G.(2012).DebtRank:TooCentraltoFail?FinancialNetworks,theFEDandSystemicRisk.ScienQficReports,2,1–6.BaSston,Caldarelli,D’errico,Gurciullo,S.(2016).Leveragingthenetwork.StaFsFcsandRiskModeling,1–33.(2)BaSston,S.,Roukny,T.,SFglitz,J.,Caldarelli,G.&May,R.ThePriceofComplexityinFinancialNetworks.PNAS(2016)www.pnas.org/content/113/36/10031.full
• ClimatepoliciesaspotenFalsourceof(endogenous)shocksto
thefinancialsystem.
• TradiFonalcost-benefitanalyses:aggregateesFmatesnotadequatetoidenFfyindividualrisksandtheirpropagaFonthroughthefinancialsystem.
• Networkanalysisoffinancialdependencies:directandindirectexposurestoclimate-policyrelevantsectorsrepresentalargepor=onofinvestors’porYolios–inparFcularforinvestmentfundsandpensionfunds.
Conclusions
Findingsofourstudy1suggestthat:• Disclosureofclimate-relevantfinancialinforma=oniskeyto
improveriskesFmaFonsandcreatetherightincenFvesforinvestors.However,beHerdisclosuremaynotbesufficient.
• The=mingandcredibilityoftheimplementaFonofclimatepoliciesmaHer.Anearlyandstablepolicyframeworkwouldallowforsmoothcarbon-assetvaluesadjustmentsandleadtopotenFalnetwinnersandlosers.
• Incontrast,alateandabruptpolicyimplementaFonwouldhaveadversesystemicconsequencesforthefinancialsystem.
Conclusions
(1)BaSston,S.,Mandel,Antoine,Monasterolo,I.,Schuetze,F.,VisenFn,G.:AClimatestress-testofthefinancialsystem.AvailableSSRNid=2726076.(2016).