Quantifying resilience of firms to climate transition risks: Modeling key drivers, quantifying elasticities, assessing impact on firm's Credit Risk

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Climate change and the transition to a low-carbon economy to mitigate it engender significant economic costs. These costs, ultimately are born by firms, affecting their Cash Flows and wealth, which are key determinants of their creditworthiness. Climate-change-related costs are thus a potential source of credit risk. A credit risk assessment of sound quality including climate credit risk is crucial for creditors and central banks alike. Underestimating losses associated with such events exposes firms to financial losses and regulators to the risks of holding assets of inadequate credit quality. These increase the need to develop expertise on the topic as regulators move towards requiring banks to conduct stress test on such risks which have -until now- been overlooked. Climate credit risk adopts a forward-looking approach based on unobserved past data and rather complex causal links. Models providing insights into such complex underpinnings are in their embryonic stage but provide meaningful insights. We propose in this research to quantify the resilience of individual firms to transition risks, specifically, we propose to model the key drivers of climate credit risk and quantify the associated elasticities. These elasticities will in turn be applied to traditional credit risk models to evaluate impacts on the creditworthiness of firms. The elasticities can also be used -at the firm level- to conduct macro stress tests for regulatory purposes.