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Climate Stress-test of the Financial System Stefano Ba*ston, FINEXUS Center for financial networks and sustainability, Dept. of Banking and Finance, Univ. of Zurich
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Climate Stress-test of the Financial System · Climate Stress-test of the Financial System ... Outline (1) Baston, S. ... Climate Policies Climate Change Financial

May 11, 2018

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Page 1: Climate Stress-test of the Financial System · Climate Stress-test of the Financial System ... Outline (1) Baston, S. ... Climate Policies Climate Change Financial

ClimateStress-testoftheFinancialSystem

StefanoBa*ston,FINEXUSCenterforfinancialnetworksandsustainability,

Dept.ofBankingandFinance,Univ.ofZurich

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•  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).

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ClimateRelevant Sectors

Financial Sectors

Shocks on financial exposures

Shocks on Financial provisions

Climate Policies

Climate Change

Financial Regulation

Systemic risk, inequality

TheSourceofComplexityintheClimate–Financenexus

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•  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

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LoanPorgoliosofMajorEuroAreaBanks–Leverageacrosssectors

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Page 9: Climate Stress-test of the Financial System · Climate Stress-test of the Financial System ... Outline (1) Baston, S. ... Climate Policies Climate Change Financial

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

Page 10: Climate Stress-test of the Financial System · Climate Stress-test of the Financial System ... Outline (1) Baston, S. ... Climate Policies Climate Change Financial

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).

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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

Page 12: Climate Stress-test of the Financial System · Climate Stress-test of the Financial System ... Outline (1) Baston, S. ... Climate Policies Climate Change Financial

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

Page 13: Climate Stress-test of the Financial System · Climate Stress-test of the Financial System ... Outline (1) Baston, S. ... Climate Policies Climate Change Financial

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

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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

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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).

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EquityholdingsinEUandUSlistedcompanies.SectorcomposiFonofaggregateinsFtuFonalsectorsworld-wideaccordingtoBvDdata2015.

Results:Exposuretoclimatesensi=vesectors

Ba#ston,S.,Mandel,Antoine,Monasterolo,I.,Schuetze,F.,Visen.n,G.:AClimatestress-testoftheEUfinancialsystem.AvailableSSRNid=2726076.(2016).

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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).

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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).

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Rela=veporYoliocomposi=onoftopworld-wideBanks:climate-sensi=vesectorsexposure

Ba#ston,S.,Mandel,Antoine,Monasterolo,I.,Schuetze,F.,Visen.n,G.:AClimatestress-testoftheEUfinancialsystem.AvailableSSRNid=2726076.(2016).

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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).

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Exercise2.ShocksobtainedfromLIMITSIAMdatabase

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Exercise2.ShocksobtainedfromLIMITSIAMdatabase

Firstroundlosses(top)andsecondroundlosses(boHom)ofa“brown”and“green”banks’equity

Page 23: Climate Stress-test of the Financial System · Climate Stress-test of the Financial System ... Outline (1) Baston, S. ... Climate Policies Climate Change Financial

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.

Page 24: Climate Stress-test of the Financial System · Climate Stress-test of the Financial System ... Outline (1) Baston, S. ... Climate Policies Climate Change Financial

ClimateRelevant Sectors

Financial Sectors

Shocks on financial exposures

Shocks on Financial provisions

Climate Policies

Climate Change

Financial Regulation

Systemic risk, inequality

TheSourceofComplexityintheClimate–Financenexus

Page 25: Climate Stress-test of the Financial System · Climate Stress-test of the Financial System ... Outline (1) Baston, S. ... Climate Policies Climate Change Financial

•  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

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•  ClimatepoliciesaspotenFalsourceof(endogenous)shocksto

thefinancialsystem.

•  TradiFonalcost-benefitanalyses:aggregateesFmatesnotadequatetoidenFfyindividualrisksandtheirpropagaFonthroughthefinancialsystem.

•  Networkanalysisoffinancialdependencies:directandindirectexposurestoclimate-policyrelevantsectorsrepresentalargepor=onofinvestors’porYolios–inparFcularforinvestmentfundsandpensionfunds.

Conclusions

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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).