Climate Stress Test: The Impact of Carbon Price Shock on the Probability of Default in the Hungarian Banking System

Abstract

This study presents the methodology and results of a transition risk climate stress test carried out for credit institutions, focusing on the methodology of a sectoral module developed for the analysis. Using a sectoral network derived from an inputoutput table, the sectoral module distributes a price shock between activities with higher greenhouse gas emission intensity and the related sectors. Results suggest that the sectors with the largest exposure to transition are electricity and gas supply. The probability of default for these two sectors may increase by 1.5 to 2.3 percentage points compared to the baseline. The transition risks for various sectors are highly heterogeneous. Based on Monte Carlo simulations, the extent of the transition risks for Hungarian banks also varies significantly. The advantage of this methodology lies in its ability to estimate the magnitude of macroeconomic shocks and the transition differences across sectors, and its ease of integration into stress testing processes.