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Innovative stress testing tool helps banks understand risk of loan default driven by drought

18 April 2017

Financial institutions and environmental experts from across the globe have partnered in a project to develop a set of environmental risk stress tests that measure the credit worthiness of bank loans.

The ‘Drought Stress Testing Tool allows financial institutions to see how incorporating drought scenarios changes the perception of risk in their own loan portfolios. Based on the catastrophe modelling framework that the insurance industry has used for 25 years, it looks at five drought scenarios in four countries – Brazil, China, Mexico and the US – to model the impact on 19 different industry sectors, the companies in those sectors and the likelihood that they will default on their loans.

A new report, ‘Drought Stress Testing – Making Financial Institutions more Resilient to Environmental Risks’, showcases the tool in action by piloting the stress test on select, sample corporate lending portfolios of nine international financial institutions. These are: Caixa Econômica Federal, Itaú Unibanco, Santander Brazil, Banorte, Citibanamex, Trust Funds for Rural Development (FIRA), Citigroup, UBS and Industrial and Commercial Bank of China (ICBC), which combined represent more than USD 10 trillion in assets.

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