A half-assed defense of the static approach to climate stress testing

“Never do anything half-assed,” Kamala Harris’ Mom told her daughters. That’s all well and good for presidential candidates, but for weary climate risk pundits like myself, half-assedness can serve a purpose.  I’m talking here about arguing for a point of view you don’t necessarily believe in. Putting yourself in someone else’s shoes.

It is in this spirit that I’m writing in defense of the ‘static portfolio approach’ to climate stress testing.  (Don’t let it ever be said that Unpacking Climate Risk doesn’t know how to have a good time).  

Put simply, the static approach calls on banks to ‘freeze’ the composition of their loan portfolios as they stand today, and estimate how they may be battered by climate risks over the 10-, 20-, 50-year or more time horizon of a given climate scenario.

This is, prima facie, kind of absurd.  Bank portfolios are ever changing.  Their make-up transforms in response to credit conditions, geopolitical shocks, regulations, and more.  Don’t believe me?  Then ask a Wall Street bank how many outstanding Russian exposures they had in 2022 and how many they have now.  In JP Morgan’s case, it was $500 million at end-2022 and $350 million a year later.  I’m betting it’s continuing to shrink rapidly.

Of course, the financial supervisors that oversee climate stress tests know this.  They know bank portfolios change day by day, year by year.  So why do they favor the static approach, as a recent review of climate stress tests showed?