Abstract
Climate change has become highly relevant for central banks, with new methods to assess the impact of climate-related shocks on the financial system developing rapidly. This paper analyzes the conceptual steps in Climate Risk Stress Testing (CRST), which is a tool to assess the impact of climate-related shocks on the stability of the financial system. We do this by disentangling climate, economic, and financial modeling steps. We identify six types of climate shocks and four approaches to CRST (macro-financial, micro-financial, non-structural, and disaster risk). We find that existing CRST exercises may underestimate potential system-wide financial losses, due to their limited scope (not including all asset classes), omittance of certain types of climate shocks (such as Green Swan and Minsky-type events), incomplete modeling (lack of feedback effects), and a strong reliance on traditional macro-financial methods with low sectoral and spatial granularity.