Our approach
Climate risks are challenging to assess accurately:
- They have long time horizons, and it is uncertain what future policy and socio-economic factors might look like.
- They are global and economy-wide in nature.
- They are complex, varying from region to region and sector to sector.
To overcome these challenges, the Bank and OSFI used scenario analysis—an innovative approach to gain a better understanding of transition risks. The scenarios in the pilot explore different possible future paths for both reducing both greenhouse gas emissions and mitigating their negative implications for the economy and financial system. They also include different assumptions for climate policy and the speed of technological change.
This approach builds on expertise the Bank has developed through staff research and our participation in the global Central Banks and Supervisors Network for Greening the Financial System. Most recently, we contributed to a number of publications to help improve global understanding of the impact of climate change on the financial system and world economy.
It’s important to note that the pilot scenarios are illustrative. They show potential stresses on the economy and the financial system. They are not predictions or forecasts, nor are they stress tests of individual financial institutions.
The scenarios also deliberately focus on transition risks rather than physical risks. These physical risks—and the steps we may take to mitigate or avoid them—could also have significant implications for the global and Canadian economies and the financial system. This is an area for future work.
Key findings
Through this pilot, participants used climate transition scenarios to explore new methodologies to support climate-related financial risk assessments. The exercise highlighted the need to develop consistent ways to analyze and disclose climate risks. And it helped participants identify data gaps and develop a deeper understanding and awareness of the impacts of the climate transition risks on their portfolios.
The climate transition scenarios developed for the pilot showed that the economy as a whole will undergo significant structural changes as the world transitions to net zero. Substantial restructuring in many sectors may be required to meet climate targets.
For commodity-exporting countries like Canada, the transition also carries risks of significant macroeconomic impacts. These are driven mostly by declines in global prices of commodities brought by changes in global climate policy.
The pilot also highlighted the important role for innovation—for example, to scale up renewable energy technologies.
And it was clear through this exercise that, whatever path is chosen, delaying action heightens the risks to the financial sector and to the entire economy.
While the report does not make specific policy recommendations, it is an important contribution to the Bank’s overall efforts to better understand and model the economic and financial implications of climate change.