Their second report concerns measurement methods. Climate-related financial risks challenge traditional measurement methods:
- Limited ability to use history as a guide for future developments.
- High data granularity compared to for instance traditional credit risk analysis is needed to assess both physical risks (geolocational data given spatially varying characteristics of climate impacts) and transition risks (counterparty- and industry level data).
- The traditional methods focus on capturing near-term risks (typically up to three to five years). Minimum capital requirements have even been designed to capture only unexpected losses over a one year horizon.
The TFCR gives an analysis of the efforts so far in developing measurement methodologies and efforts to address above challenges. Click here for a summary. An understanding of the transmission channels is essential to develop proper measurement methodologies and indeed is a cornerstone in their conceptual framework to assess climate-related risks.
To date, measurement of climate related financial risks has a spotlight on mapping near-term transition risk drivers into bank exposures. Credit risk measurement has attracted the most effort, with a lesser focus on other risk categories. Initial scenario analyses and stress tests have in many cases focused on selected portfolios or exposures for transition risks, and selected hazards for physical risks. The TFCR concludes that key areas for further analysis relate to gaps in data and risk classification, as well as methodologies to address uncertainties associated with the nature of climate change and the potentially longer time horizon for risks to manifest.
We do see increasingly initiatives to bring the analysis of physical and transition risks together in a consistent and coherent way and move beyond the traditional practice among climate researchers to assess these risk types separately.