Low-Carbon Transitions and Systemic Risk

The low-carbon transition has been cited by policymakers as a potential driver of systemic risk that could lead to financial instability and negative macroeconomic outcomes. This work provides a survey of the literature on the approaches used to assess systemic transition risk. It begins by drawing on the frameworks of central banks and academic studies to identify the channels through which systemic risk could materialise under a low-carbon transition, and then provides a detailed assessment of the indicators and modelling frameworks that have been explored. These include:

• Monitoring indicators of banks’ exposure to high-carbon sectors
• Climate-related stress testing
• Integrated Assessment Models (IAMs) to estimate the first-order financial impacts
• Models of production and financial networks to estimate the second round effects from contagion

We also highlight the main gaps in the literature on tracking and modelling systemic transition risks, and areas for future research, such as:

• Improved data collection and monitoring of exposure to carbon-intensive (and green) assets.
• Transition risk scenarios in stress tests that account for feedback loops between financial market participants, and between the financial system and the real economy.
• Comprehensive modelling approaches which include both production and financial networks, as well as the impact from rising and declining industries.