Climate scenarios as transition planning tools for EU banks

Abstract

Originally developed for military planning and policy-making purposes, scenario analysis has increasingly been recognized in financial and banking regulation as a key technique for identifying and managing climate and environmental risks. Unlike traditional risk assessment models, scenario analysis captures forward-looking and non-linear risks under conditions of fundamental uncertainty. A growing body of rules and supervisory expectations urges banks to integrate scenario-based methodologies into (climate-related) stress testing exercises and transition plans. This paper examines the legal basis for requiring banks to conduct climate scenario analyses under the EU prudential and corporate framework, exploring their role as a risk-management, strategic planning and disclosure tool. We analyse the powers of supervisory authorities to prescribe and scrutinize climate scenario exercises as well as banks’ obligations to ground their transition planning strategies in scientifically sound scenarios. We argue that, despite the versatile nature of these tools, banks are expected to operate in a persistent state of legal uncertainty.