Stefan is a PhD candidate at University College London (UCL) and a visiting researcher at the University of Cambridge.
Research Question
Governing Financial System Transformation to Climate Resilience: Which adaptive capacity developments are essential to implement governance strategies that improve financial system resilience to hydro-meteorological hazards?
The crisis of response to climate change in aligning finance with climate risk management is a current threat that could deteriorate the very assets we invest in. The misaligned strategies from the financial industry in long-term asset investment and a potential failure to respond to climate risk seems like a climate action paradox for sustainable financial development. If we exceed the climate scenarios that no longer protect those assets, we move into a direction of unsustainable economic development and put the well-being of our society at risk.
Introduction to Financial Systems, Resilience, Adaptive Governance & Climate Science
Financial institutions are assessing the changing exposure to climate impacts and are beginning to identify the systemic risks climate change is posing on the financial system, and more importantly, the well-being of our society. The objective of the research is to point out how new knowledge generation, adaptive governance strategies and institutional capacity building can impact transformational trajectories, and what that would imply from the perspective of different financial institutions. The study aims to look at the systemic implications of climate change on financial systems, and to determine how different types of transformation scenarios, and their trajectories, would change the exposure/vulnerability, and therefore the resilience to hydro-meteorological risks.
The creation of knowledge through quantified approaches to modelling climate risk, a better understanding of necessary adaptive governance mechanisms in financial institutions, and capacity building elements are the essential preconditions to develop climate resilience and system stability. Inadequate modelling approaches, hindering institutional capacities, and non-linear systemic impacts are identified as challenges to how financial institutions can create new actionable knowledge. In turn, new knowledge generation can facilitate the development of more adaptive institutional responses and governance mechanism with respect to changing climate risk. Integrating complexity theory into knowledge management and organisational learning is a necessary development for reducing climate vulnerabilities and tackling mis-matched time horizons in the climate response.
Socio-Ecological Modelling and Financial Systems: Opportunities in using scenario-based behavioural modelling approaches to develop climate risk informed decision-making processes
Evolutionary modelling techniques, such as Agent-based Modelling (ABM), pose an opportunity for financial systems to integrate scenario analysis. Modelling the interactive feedback loops between climatic and financial systems, while also taking behavioural factors into account, can improve decision-making processes to be more “adaptive”. As Agent-based Models (ABMs) have seen little application in a financial setting, there is an opportunity for enhancing financial decision-making processes with information derived from coupling socio-ecological models within a climate financial integrated assessment framework. In this pilot study, a case study is presented that exemplifies this approach to arrive at an understanding of how innovative multi-year insurance policies can address un/insurability of physical assets, and how the over-reliance on the insurance industry increases risks across the financial system.
The study concludes that financial modelling approaches are not sufficiently equipped to deal with climate risk. A multi-model assessment framework (as opposed to adjusting standalone models) can more appropriately factor in systemic complexities in socio-ecological systems, creating narratives based on quantified approaches to modelling climate risk instead of just aiming at quantifying climate value at risk. This can engage decision makers more effectively to deeply understand these complex dynamics.
Additionally, promoting risk/vulnerability reduction matched with a multi-year insurance offering could, in the long term, keep assets insurable, and limit the systemic implication. In order to develop resilient financial systems, engaging broader financial systems involvement in managing climate risk through transparent, collaborative and incentive aligned approaches could further limit systemic risks posed by climate change.