Chapter 6

Question 1

Credit Risk Metrics

Answer 1

1. Probability of Default (PD)
2. Loss Given Default (LGD)
3. Exposure at Default (EAD)

Question 2

Probability of Default

Answer 2

Likelihood of someone/something not being able to meet their Financial obligations (repaying loans/debts)

Question 3

Loss Given Default

Answer 3

Amount of money lender is likely to lose if a borrower defaults on a loan or debt

Question 4

Exposure at Default

Answer 4

Total amount of money or credit lender is exposed to when a borrower defaults on a loan or debt

Question 5

Credit Risk - Macro level risks

Answer 5

Significant - sector wide asset stranding or change in demand can impact sector revenues and increase sector level PD - posing financial stability risks in important sectors and for exposed Financial Insitutions

Question 6

Credit Risk - Micro level risks

Answer 6

Transition Risks: Asset stranding could worse a firm’s Financial position (higher PD and LGD for a lender given decrease in asset valuations)

Physical Risks: lead to loss of revenue and profits - worsening firm’s Financial position and increasing PD

Question 7

Operational Risk Metrics

Answer 7

1. Proportion of facilities in risky areas
2. Level of company preparedness

Question 8

Operational Risk - Micro level

Answer 8

Transition Risk: abrupt policy change leading to facility shutdown

Physical Risk: more frequent and severe extreme weather will cause property damage and business interruption

Question 9

Operational Risk - Macro level

Answer 9

Limited - only under specific set of circumstances (sector has high geographic concentration_; potential for climate to cause system/Financial stability risk

Question 10

Liquidity Risk Metrics

Answer 10

1. Load to deposit ratio (banks)
2. Liquidity Ratios
3. Bid-ask spread (markets)

Question 11

Liquidity Ratios

Answer 11

Helps assess a company’s ability to meet its short-term financial obligations

Liquidity ratio = (current assets) / (current liabilities)

Question 12

Bid-ask spread

Answer 12

Difference between highest price a buyer is willing to pay for an asset (bid price) and lowest price a seller is willing to accept for that same asset (offer/ask price)
ex: trading stocks, bonds, currencies

Question 13

Climate Minsky Moment

Answer 13

Sudden and sever market or financial crisis caused by abrupt recognition of risks associated with climate change
ex: high number of asset stranding leading to financial crisis

Question 14

liquidity risk - micro level

Answer 14

Both TR and PR can prompt sharp repricing and sudden market re-evaluation of firm’s viability, leading to liquidity shock therefore leading to widening of bid-ask spreads

ex: abrupt climate event can prompt large demand for deposit withdrawals at banks, leading to increase in load-to-deposit reatios

Question 15

Liquidity risk - macro level

Answer 15

Significant - climate minsky moment could cause abrupt and wide enough repricing and dislocation to constitute a market liquidity shock

Question 16

Underwriting Risk metrics

Answer 16

1. Change in insurance premiums
2. Availability of Insurance

Question 17

Underwriting risks - micro level

Answer 17

TR: lead to decrease in insurance availability, as some insurers refuse to underwrite certain kinds of activities and facilities

PR: lead to increase in insurance premiums for corporations or certain facilities in vulnerable areas to become uninsurable

Question 18

Underwriting risk - macro level

Answer 18

Significant - if number of insurers withdraw or refuse coverage, leaves firms completely without coverage therefore amplifying risks to financial stability

Question 19

Market risks metrics

Answer 19

1. Weighted Average Carbon Intensity
2. Climate Value at Risk
3. Portfolio Risk scores

Question 20

Climate Value at Risk (Cl. VaR)

Answer 20

Risk assessment tool that quantifies potential financial losses a company or portfolio could incur due to climate change

Question 21

Market Risk - micro level

Answer 21

Both PR and TR can become more widely incorporated in asset prices (through abrupt pricing and more gradual changes)

Large scale shifts in input and product markets affect non financial corporations.

Shifts in asset price increases risk of FI portfolios

Question 22

Market Risk - macro level

Answer 22

Significant - climate risk is expected to produce sector and market wide repricing of many assets and commodities therefore causing dislocation and system risk

Question 23

Sovereign risk metrics

Answer 23

1. proportion of budget revenues from fossil fuels
2. vulnerability to physical climate risks

Question 24

Sovereign risks - micro level

Answer 24

PR: can cause countries that are particularly vulnerable to have higher costs of damage and lower GDP growth

TR: heavily affect countries reliant on fossil fuel production for a substantial proportion of GDP and government tax revenue

Question 25

Sovereign risk - macro level

Answer 25

Many countries have diversified economies and geographies, but some countries are heavily exposed to PR and TR and likely to be severely affected

Question 26

Operational Risk

Answer 26

Risk in doing business

Question 27

Credit Risk

Answer 27

Ability borrower has to pay back a loan

Question 28

Liquidity Risk

Answer 28

Ability to easily convert assets into cash

Question 29

Underwriting Risk

Answer 29

Ability for insurers to insure

Question 30

Important transmission channel that leads to credit risk

Answer 30

operational risk climate change - leads to operational risk - leads to credit risk ex: climate risk causes raw materials to become more expensive, makes products decrease in value

Question 31

To properly assess Transition Risk

Answer 31

a. multiple types of data b. appropriate analytical tools to understand application to user's needs c. accurate asset level and company level data on GHG emission d. data on policy landscapes, technological changes and consumer preferences

Question 32

To properly assess Physical Risk

Answer 32

a. data on current and future physical hazards (historical data + climate models) b. topographical data c. locational data of assets d. info on vulnerabilites and adaptive capacities

Question 33

Weighted average carbon intensity

Answer 33

tons of CO2 equivalent / million USD where "tons of Co2 equivalent" is = money invested; and /mill USD is mill USD of revenue

Question 34

ERM approach

Answer 34

1. Governance and Culture 2. Strategy and Objective setting 3. Performance 4. Review and revision 5. Info, communication and reporting

Question 35

Governance and culture

Answer 35

Board and senior executives - understanding and diffusion of climate knowledge

Question 36

Strategy and objective setting

Answer 36

high level decisions on organization's prioritization and missions 1. SWOT Strength, weakness, opportunities, threats) 2. impact and dependency mapping (stock and flow in terms of capital) 3. materiality assessment (SASB framework)

Question 37

Performance

Answer 37

1. risk identification - examine transmission channels of climate risk drivers in f risk (what are most relevant for particular orgs) 2. risk assessment and prioritization (gather data on scope of these risks - i.e. portfolio level analysis ; rank risks based on what will be most impacted and what is most important (profit, revenue, asset valuation) 3. implementation of risk response (1.acceptance (accepting impact and not taking action); 2.avoidance (removing risk completely and anythin related to it (ex: refusal to invest in FF); 3. pursuit (converting risks into opportunities); 4.reduction (improvement in processes, systems, strategies); 5.sharing (collaboration as risk mitigation strategy))

Question 38

Review and revision

Answer 38

reassess risks in light of changes and analyze effectiveness of ERM processes

Question 39

info, communication and reporting

Answer 39

communication to board, senior managers, external stakeholders (investors, suppliers, employees, regulators, public)

Question 40

Which risk has only limited potential for systemic impact on F stability

Answer 40

operational risk

Question 41

what is not an important climate risk transmission channel

Answer 41

physical risk leads to damage and supply chain disruption, increasing market wide liquidity risk

Question 42

what are key shortcomings of physical risk scores

Answer 42

1. incorporate multiple hazards, but methods that they are calculated are in black box 2. normalization of raw data means physical risk scores are only relative, not absolute

Question 43

Transition risks

Answer 43

1. policy regulation 2. technology development 3. consumer preferences

Question 44

Physical risks

Answer 44

1. Chronic (temperature, precipitation, sea levels) 2. Acute (heatwaves, floods, wildfires)

Question 45

SASB

Answer 45

Sustainability Accounting Standards Board - 1. materiality 2. indsutry specific 3. Quantitative and Qualitative Disclosure: 4. Integration with Financial Reporting: 5. Stakeholder Engagement 6. Transparency: