Originally developed
for military planning and policy-making purposes, scenario analysis has
increasingly been recognized in financial and banking regulation as a key
technique for identifying and managing climate and environmental risks. Unlike
traditional risk assessment models, scenario analysis captures forward-looking
and non-linear risks under conditions of fundamental uncertainty. A growing
body of rules and supervisory expectations urges banks to integrate
scenario-based methodologies into (climate-related) stress testing exercises
and transition plans. This paper examines the legal basis for requiring banks
to conduct climate scenario analyses under the EU prudential and corporate
framework, exploring their role as a risk-management, strategic planning and
disclosure tool. We analyse the powers of supervisory authorities to prescribe
and scrutinize climate scenario exercises as well as banks’ obligations to
ground their transition planning strategies in scientifically sound scenarios.
We argue that, despite the versatile nature of these tools, banks are expected
to operate in a persistent state of legal uncertainty.