Regardless of which sourcing options—or combinations of options—banks choose, customizing and reducing the scenarios by downscaling will be critical for carrying out meaningful climate scenario analysis. The choice of source(s) for the climate scenario analysis also needs to be based on the bank’s current profile and exposure to each type of climate-related risk.
To properly execute climate scenario analysis, the following steps need to be taken:
1. Perform a preparedness assessment:
Using emerging regulatory requirements and guidelines3 identify data elements necessary to support the analysis and reporting and the data sources for such data elements, as well as the lineage of the data elements from source to output and disclosure.
2. Establish strategic plans to fill in assessment gap:
This should include sourcing and procuring climate scenario pathways and resulting macroeconomic scenarios from external, third-party sources, as well as developing processes and procedures to onboard scenarios. Review scenarios in accordance with bank and regulatory requirements. In cases where the bank can develop its own scenarios in-house, a framework should be established to substantiate the developed scenarios against such requirements.
3. Establish the climate scenario analysis framework:
To build a rigorous framework, consider the following:
- Develop processes and procedures to enable the bank to make modifications and/or adjustments to climate and macroeconomic scenarios supported by statistical, scientific, and economic leading practices.
- Review existing loss forecasting models across portfolios to determine which models (or components) can be leveraged for climate risk forecasting with modification. If existing models cannot be relied upon as a starting point for climate risk modeling, then design and develop new climate risk forecasting models across the bank’s portfolios for both physical and transition risks.
- Generate model business requirements, data extract, transform, and load (ETL) code, estimation code and logic, statistical analysis and support, forecasting code and logic, and model documentation.
KPMG supports banks and other financial institutions in their end-to-end climate risk quantification journey, starting with risk identification and exposure assessment, data and scenario sourcing, climate mediated credit-risk modeling, and communication of physical and transition risk impacts on their portfolios.
