The NGFS, founded in December 2017, is a group of central banks and supervisors with 165 members (as of January 2025) that shares best practice and contributes to the development of environmental and climate risk management in the financial sector.
Assessing the economic impacts of climate change is difficult in the context of insufficient data, metrics, tools, and fundamental uncertainty in the tail end of the distribution. To analyze how climate change and the transition could take shape, the NGFS provides scenarios (or “narratives”) based on current scientific consensus to serve as common reference point (available at www.ngfs.net/ngfs-scenarios-portal/).
- The NGFS advocates for and implements an incremental approach to developing scenarios based on evolving scientific evidence, and it aims to be transparent about the underlying assumptions in each update.
- The long-term scenarios currently measure chronic risks (from gradual changes) and acute risks (from extreme events) separately. Chronic risk assessments rely on a top-down approach with macroeconomic damage functions, while acute risk assessments aggregate granular impacts from peril-specific models. Recent advancements in modeling the macroeconomic impact of chronic damages point toward higher damages than previously considered.
The strengths of using top-down empirical damage functions for chronic risks are their data-based approach and relative simplicity. However, this approach relies on past data and struggles to capture nonlinear damages and the impact of crossing climate tipping points. In November 2024, the NGFS published Phase V of its climate scenarios of central banks and supervisors. These scenarios introduce a damage function based on Kotz et al. (2024), which offer two advances: (1) a broader scope of climate variables (e.g., accounting for temperature and precipitation variability as well as the mean) and (2) modeling semi-persistent effects of climate shocks on economic growth, which provides a middle ground between purely transitory impacts and permanent effects on growth. The method points to higher damages than previously considered.
Forward-looking assessments of the macroeconomic impacts of acute risks are difficult due to the multiplicity of transmission channels and second-round effects. Past NGFS iterations have expanded the set of acute perils considered from flood risk and cyclones to also include droughts and heatwaves. Future developments include improving the interaction with chronic risks, as expansion of the variables considered in damage functions may increase the risk of overlap.
MoFs can use NGFS scenarios to assess, for instance, the cost of a lack of mitigation in the long run or the scale of the adaptation challenge. However, there is no one-size-fits-all approach to physical risk modeling. Employing the scenarios should be based on an understanding of their underlying hypotheses and limitations and requires complements to meet users’ specific objectives.
Keywords
analytical toolsmodelsphysical risk
