What are the NGFS climate scenarios, and how do banks use them for transition risk assessment?

The Network for Greening the Financial System (NGFS) provides a set of standardized climate scenarios that central banks and financial institutions use to assess how different climate transition pathways affect financial portfolios. These scenarios vary by the level of policy ambition and the orderliness of the transition.\n\nThe Six NGFS Scenarios (Phase IV Framework):\n\n`mermaid\ngraph TD\n A[\"NGFS Climate Scenarios\"] --> B[\"Orderly Transition\"]\n A --> C[\"Disorderly Transition\"]\n A --> D[\"Hot House World\"]\n B --> E[\"Net Zero 2050
1.5C target, smooth\"]\n B --> F[\"Below 2C
Gradual, moderate\"]\n C --> G[\"Divergent Net Zero
Uneven sector policies\"]\n C --> H[\"Delayed Transition
Late, abrupt action post-2030\"]\n D --> I[\"Nationally Determined
Current pledges only\"]\n D --> J[\"Current Policies
No new action\"]\n style E fill:#10b981,color:#fff\n style H fill:#f59e0b,color:#000\n style J fill:#ef4444,color:#fff\n`\n\nKey Variables Each Scenario Specifies:\n- Carbon price trajectory ($/tonne CO2)\n- Energy mix evolution (fossil vs. renewable share)\n- GDP growth path\n- Temperature outcome by 2100\n- Physical risk intensity\n\nPractical Application at Ashwick National Bank:\n\nRisk analyst Francesca must assess the impact of NGFS scenarios on the bank's $15 billion corporate loan portfolio.\n\nStep 1: Map portfolio to carbon-sensitive sectors\n\n| Sector | Exposure | Carbon Intensity |\n|---|---|---|\n| Oil & Gas | $1.8B | Very High |\n| Utilities (coal) | $0.6B | Very High |\n| Transportation | $1.2B | High |\n| Manufacturing | $2.4B | Medium |\n| Technology | $3.5B | Low |\n| Other | $5.5B | Low |\n\nStep 2: Apply scenario-specific carbon price shocks\n\n| Scenario | Carbon Price 2030 | Carbon Price 2050 | Oil & Gas Revenue Impact |\n|---|---|---|---|\n| Net Zero 2050 | $130/tonne | $250/tonne | -35% by 2035 |\n| Delayed Transition | $25/tonne (then spike to $350) | $350/tonne | -15% by 2030, then -55% by 2040 |\n| Current Policies | $15/tonne | $25/tonne | -5% (physical risk driven) |\n\nStep 3: Translate to credit metrics\n\nUnder the Delayed Transition scenario (highest transition risk):\n- Oil & Gas portfolio: PD increases from 2.1% to 8.7% by 2035\n- Coal utilities: PD increases from 3.4% to 15.2% by 2035\n- Expected credit losses on carbon-intensive sectors: increase by $340 million over 10 years\n- Capital impact: additional CET1 requirement of approximately $85 million\n\nStep 4: Report to management and regulators\n\nFrancesca presents the range of outcomes across scenarios, highlighting that the Delayed Transition creates the highest financial risk because the abrupt policy shift doesn't give borrowers time to adapt.\n\nWhy This Matters for FRM:\n- Climate scenario analysis is now required by many regulators (ECB, PRA, MAS)\n- The NGFS framework provides comparability across institutions\n- Transition risk affects PD, LGD, and EAD through multiple channels\n- Physical risk (floods, droughts, storms) affects collateral values and operational continuity\n\nStudy emerging risk topics in our FRM study resources.