Climate Risk and Financial Stability in the Network of Banks and Investment Funds

48 Pages Posted: 8 Apr 2019

See all articles by Alan Roncoroni

Alan Roncoroni

University of Zurich - Department of Banking and Finance

Stefano Battiston

University of Zurich - Department of Banking and Finance; Swiss Finance Institute

Luis Onésimo Leonardo Escobar Farfàn

Banco de Mexico

Serafin Martinez Jaramillo

Bank of Mexico

Date Written: March 19, 2019

Abstract

We develop a method to analyze the effects on financial stability of the interplay between climate policy shocks and market conditions. We combine the frameworks of the Climate Stress-test with the framework of the network valuation of financial assets, in which the valuation of interbank claims accounts for market volatility as well as for endogenous recovery rates consistent with the network of obligations. We also include the dynamics of common asset contagion involving not only banks but also investment funds, which are key players in the low carbon transition. We then apply the model to a unique supervisory data-set of banks and investment funds at the firm level in order to assess the impact for financial stability of shocks deriving from the disorderly alignment of energy and utility sectors in a range of climate policy scenarios. While under mild shock scenarios systemic losses are contained, we identify the climate policy scenarios and market conditions under which systemic losses can pose a threat to financial stability.

Keywords: financial stability, climate risk, sustainable finance, climate stress-test, low-carbon transition risk, 2°C opportunities

JEL Classification: D85, D86, E58, G01, Q54

Suggested Citation

Roncoroni, Alan and Battiston, Stefano and Escobar Farfàn, Luis Onésimo Leonardo and Martinez Jaramillo, Serafin, Climate Risk and Financial Stability in the Network of Banks and Investment Funds (March 19, 2019). Available at SSRN: https://ssrn.com/abstract=3356459 or http://dx.doi.org/10.2139/ssrn.3356459

Alan Roncoroni

University of Zurich - Department of Banking and Finance ( email )

Schönberggasse 1
Zurich
Switzerland

HOME PAGE: http://https://www.bf.uzh.ch/en/persons/roncoroni-alan

Stefano Battiston (Contact Author)

University of Zurich - Department of Banking and Finance ( email )

Andreasstrasse 15
Zürich, 8050
Switzerland

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Luis Onésimo Leonardo Escobar Farfàn

Banco de Mexico ( email )

Ave Cinco e Mayo 1
Col. Centro
Mexico City, Mexico DF 06059
Mexico

Serafin Martinez Jaramillo

Bank of Mexico ( email )

Av. 5 de Mayo # 1
Colonia Centro
Mexico City, D. F. 06059
Mexico

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