Skip to main content

LUP Student Papers

LUND UNIVERSITY LIBRARIES

A Framework for Navigating Climate Uncertainty - Scenario Analysis for Financial Institutions in the EU

Kovacevic, Anastasija LU and Begic, Andrea (2024) In Master's Thesis in Mathematical Sciences FMSM01 20241
Mathematical Statistics
Abstract
In response to regulatory directives mandating climate risk assessment and mitigation by financial institutions, this thesis examines the broader impact of climate change on this sector. The European Union's CRR3/CRD6 mandates the integration of climate risks into financial institutions' Internal Capital Adequacy Assessment Process (ICAAP), guided by the European Banking Authority (EBA). Through a 10-year horizon climate scenario analysis, policy implications on income streams and sectoral performance are explored. This analysis provides insights for effective risk management strategies. Sectors like oil, gas, coal, aviation, cement, steel, and power are identified as particularly vulnerable to regulatory shifts driven by evolving climate... (More)
In response to regulatory directives mandating climate risk assessment and mitigation by financial institutions, this thesis examines the broader impact of climate change on this sector. The European Union's CRR3/CRD6 mandates the integration of climate risks into financial institutions' Internal Capital Adequacy Assessment Process (ICAAP), guided by the European Banking Authority (EBA). Through a 10-year horizon climate scenario analysis, policy implications on income streams and sectoral performance are explored. This analysis provides insights for effective risk management strategies. Sectors like oil, gas, coal, aviation, cement, steel, and power are identified as particularly vulnerable to regulatory shifts driven by evolving climate ambitions outlined in the Paris Agreement. The thesis analyzes three climate policy scenarios and presents a framework for incorporating climate risks into ICAAP, projecting sectoral dynamics in response to varying climate ambitions. These insights inform base scenario analyses, facilitating the evaluation of financial trajectories across different climate scenarios. Additionally, the impact of increased natural disaster frequency on market dynamics is explored, with findings suggesting minimal or insignificant influence. (Less)
Popular Abstract
Climate Scenario Analysis for Financial Institutions

Climate change isn’t just an environmental concern; it’s a financial one too. With new regulatory demands, financial institutions must include climate scenario analysis in their ICAAP. This thesis explores three scenarios with varying regulatory ambitions, forecasting sector performance over the next decade and finding that natural disasters have a surprisingly small impact on market dynamics. This research highlights the crucial intersection of climate policy and
financial stability, offering guidance for navigating a changing economic landscape.

By defining three different short-term climate scenarios, ranging from low policy ambition to high policy ambition, the thesis... (More)
Climate Scenario Analysis for Financial Institutions

Climate change isn’t just an environmental concern; it’s a financial one too. With new regulatory demands, financial institutions must include climate scenario analysis in their ICAAP. This thesis explores three scenarios with varying regulatory ambitions, forecasting sector performance over the next decade and finding that natural disasters have a surprisingly small impact on market dynamics. This research highlights the crucial intersection of climate policy and
financial stability, offering guidance for navigating a changing economic landscape.

By defining three different short-term climate scenarios, ranging from low policy ambition to high policy ambition, the thesis explores sensitive sectors such as oil and gas, coal, aviation, steel, cement, and power in each scenario. PACTA, a free tool that gives financial institutions the opportunity to view portfolio exposures to these sectors, enables forecasting of potential trajectories. This allows financial institutions to better prepare for an uncertain future regarding climate change. The findings reveal that there might be situations where these sectors do not keep up with the changing policy landscape or situations where they thrive under low policy ambition, highlighting the complex reality of climate policy impacts.

Moreover, sectors connected to fossil fuels—whether through exploitation and sales or by relying on them as key components in their value chains—tend to follow current development trends in a low policy ambition scenario. Conversely, sectors less dependent on fossil fuels do not thrive as much in these conditions, as many of their technologies and products are still under development and remain costly to produce. In a high policy ambition scenario, however, the roles are reversed.

In addition to analyzing these sectors under different scenarios, this research delves deeper into the potential consequences of a low policy ambition scenario. One of the most critical and widely discussed topics in this context is the increased frequency of natural disasters. The study thoroughly examines the relationship between natural disasters and market dynamics, revealing that the occurrence of such events does not significantly impact market dynamics, even if their frequency were to double. However, this finding should not lead portfolio managers to disregard the importance of climate action. The urgency of addressing climate change remains paramount. (Less)
Please use this url to cite or link to this publication:
author
Kovacevic, Anastasija LU and Begic, Andrea
supervisor
organization
course
FMSM01 20241
year
type
H2 - Master's Degree (Two Years)
subject
publication/series
Master's Thesis in Mathematical Sciences
report number
LUTFMS-3498-2024
ISSN
1404-6342
other publication id
2024:E43
language
English
id
9163860
date added to LUP
2024-06-19 09:49:06
date last changed
2024-06-19 09:49:06
@misc{9163860,
  abstract     = {{In response to regulatory directives mandating climate risk assessment and mitigation by financial institutions, this thesis examines the broader impact of climate change on this sector. The European Union's CRR3/CRD6 mandates the integration of climate risks into financial institutions' Internal Capital Adequacy Assessment Process (ICAAP), guided by the European Banking Authority (EBA). Through a 10-year horizon climate scenario analysis, policy implications on income streams and sectoral performance are explored. This analysis provides insights for effective risk management strategies. Sectors like oil, gas, coal, aviation, cement, steel, and power are identified as particularly vulnerable to regulatory shifts driven by evolving climate ambitions outlined in the Paris Agreement. The thesis analyzes three climate policy scenarios and presents a framework for incorporating climate risks into ICAAP, projecting sectoral dynamics in response to varying climate ambitions. These insights inform base scenario analyses, facilitating the evaluation of financial trajectories across different climate scenarios. Additionally, the impact of increased natural disaster frequency on market dynamics is explored, with findings suggesting minimal or insignificant influence.}},
  author       = {{Kovacevic, Anastasija and Begic, Andrea}},
  issn         = {{1404-6342}},
  language     = {{eng}},
  note         = {{Student Paper}},
  series       = {{Master's Thesis in Mathematical Sciences}},
  title        = {{A Framework for Navigating Climate Uncertainty - Scenario Analysis for Financial Institutions in the EU}},
  year         = {{2024}},
}