However, climate-related risks have certain characteristics that hamper their inclusion in ratings and internal risk models. First, historical data do not capture them adequately. Second, physical risks are potentially non-linear and expected to primarily materialise in the medium to long term. And third, the future pathway of climate change and climate action is highly uncertain, not least because it heavily depends on political decisions.
In this context, scenario analysis is a particularly useful tool. Furthermore, it is important that banks take a forward-looking approach and consider a longer than usual time horizon. The ECB Guide on climate-related and environmental risks outlines the supervisory expectations and sets an ambitious goal: to fully integrate all relevant climate-related risks into banks’ risk management, business strategy and internal organisation.