Climate finance is a central research area for PRISMA, with the project aiming to develop novel representations of macroeconomic and financial sector dynamics within integrated assessment models (IAMs). PRISMA integrates stakeholder engagement throughout its project life cycle, with stakeholder input structured through different workstreams, including climate finance. At a plenary session at the 16th Integrated Assessment Modeling Consortium (IAMC) Annual Meeting in Venice in November 2023, PRISMA researchers had the opportunity to engage with policy stakeholders working on climate-related financial risk, gain insight on how state-of-the-art modelling approaches are used in this area and identify key areas in which further improvements are required.
The following speakers presented at the session:
- Steven Rose, Electric Power Research Institute (Chair)
- Livio Stracca, Head of International Policy Analysis at the European Central Bank and Adjunct Professor at the University of Frankfurt J.W. Goethe
- Ivan Faiella, Coordinator of the Climate Change and Sustainability Hub, Banca d’Italia
- Gianni Guastella, Associate Professor in Applied Economics, Università Cattolica & Deloitte Climate and Sustainability
Other stakeholders present at the IAMC meeting and with whom PRISMA researchers interacted included representatives of the IMF, the World Bank, and the OECD, as well as representatives of various European and non-European Finance Ministries.
Climate-related financial risks can materialise as a consequence of both physical risks (e.g., climate impacts affecting supply chains, capital stocks or productivity) and transition risks (e.g. falling asset values due to decarbonisation). One core insight highlighted by the session was that climate-related financial risks can manifest at different levels of the economy. Each presentation focused on a specific level of analysis: macroeconomic or European, national and firm level.
Livo Stracca discussed climate-related financial risks at the macroeconomic level, particularly highlighting risks stemming from impacts of climate change and climate policy on variables such as employment, inflation and productivity. Stracca presented the latest updates of the Network for Greening the Financial System (NGFS) scenarios, developed in part by the European Central Bank (ECB) and also incorporating contributions by researchers involved in the PRISMA project. One key advantage of these scenarios emphasised by Stracca is that, in contrast to many transition scenarios implemented by IAM frameworks, the NGFS scenarios incorporate economic impacts of climate change. The comparative user-friendliness and accessibility, as well as the frequency with which the NGFS scenarios are updated were also highlighted. Challenges chiefly relate to the difficulty of interpreting the outputs of the large range of complex models which are involved in producing the scenarios. Stracca emphasised that the addition of short-run scenarios, particularly ones examining the short-run impacts of climate change and climate policy, is a key area in which further developments are required to make scenarios more useful for policy-makers and financial institutions.
The presentation of Ivan Faiella focused on analyses of climate risk at the national level. While many of the key issues and variables of interest are similar to those relevant for the European level, data availability can allow for more detailed analyses. As an example, Faiella outlined the approach used by Banca d’Italia to conduct climate-stress tests on Italian households and firms, involving a micro-simulation model which is subjected to a climate policy shock. This allows for a direct estimate of the impacts on household and firm incomes and balance sheets, but with the caveat that the modelling framework is static and lacks a connection to the macroeconomic level to assess possible systemic risks.
Gianni Guastella focused on how scenarios such as those provided by the NGFS can support the private sector in conducting firm level assessments of climate-related risk. He highlighted that scenarios are used in two main ways. Firstly, and more broadly, the scenarios and the narratives which are attached to them provide an important frame of reference for strategic decision-making. Secondly, at a more technical level, scenarios combining physical and transition risks can be used as inputs for to understand the exposure of asset portfolios to climate risk by linking scenarios and accordingly constructed climate physical or policy shocks to key performance indicators of firms. In this context, Guastella highlighted that better estimates of climate damages and in particular asset level damage functions were a key area in which improvements are required.
Stakeholders from financial institutions at the session emphasised that policy-makers typically work on political cycles which are shorter than the timeframe of assessments typically produced by IAMs, frequently even shorter than the length of a single time-step in an IAM (which is often 5 years). Improved temporal granularity and better analyses of short-run climate impacts hence clearly emerged as key areas in which further developments are needed. Advancements in the depiction of financial dynamics in IAMs, including issues such as the impact of climate change and climate policy on public budgets and financial stability were also frequently mentioned as important stakeholder needs. Stakeholders also noted that improvements in regional and sectoral granularity are crucial for an improved assessment of climate risks.
PRISMA aims to make significant contributions to addressing these stakeholder concerns. Increased granularity, in both time and space, is a cross-cutting theme of the project and the project already employs some models that can depict short-run dynamics. This research area aligns closely with stakeholder prioritisation of the importance of both the level of the assessment and the need for more short-term scenarios. PRISMA will also deliver improvements on the quantification of climate risk, particularly through the incorporation of damages and adaptation in a larger range of scenarios. Finally, PRISMA’s dedicated work package on climate finance will develop and deploy financial sector dynamics within existing IAMs, in particular focusing on presenting new scenarios and associated narratives, building on the Shared Socioeconomic Pathways (SSPs) and the NGFS scenarios.
Author: BRUEGEL
This event has received funding from the European Union’s HORIZON Research and Innovation Actions under grant agreement No. 101081604 – PRISMA.
Views and opinions expressed are however those of the speaker(s) only and do not necessarily reflect those of the European Union or the European Climate, Infrastructure and Environment Executive Agency (CINEA). Neither the European Union nor the granting authority can be held responsible for them.