6.2. Resilience analysis

Institutions should build their resilience analysis with a view to assessing their capacity to sustain their strategic direction and profitability under adverse conditions.

As a starting point for resilience analysis, institutions should carry out a thorough analysis of the environment in which they operate, and its expected evolution over a foreseeable future.

On this basis, institutions should set their own scenario of reference, i.e. the scenario which reflects the most likely environmental path that future developments could take according to the institution. This internal reference scenario builds on the baseline scenario used for stress tests but extends over a long-term horizon and may, as a result, deviate to varying degrees from the continuation of observable trends.

In addition to the reference scenario, institutions should also select a set of distinct alternative scenarios designed to cover a wide range of plausible futures. FINAL REPORT ON GUIDELINES ON ENVIRONMENTAL SCENARIO ANALYSIS

When performing resilience analysis, institutions should consider the feedback loops stemming from the adaptation of the financial sector to rising risks (e.g., reduced insurance coverage in climate-vulnerable regions lowering asset values and creditworthiness, which in turn amplifies financial losses and limits future investment) and its contribution to the financing needs of the economy. To this end, institutions should monitor capital reallocation movements and possible crowding-out effects in sectors or subsectors most affected by transition efforts (e.g., a shift away from carbon-intensive sectors due to increased risk perception, or excessive investor focus on green assets leading to mispricing and reduced financing availability for transitional sectors or vulnerable SMEs).

In parallel to this thorough analysis of their environment, institutions should identify key features of their current business model, including underlying profitability, assets and liabilities mix, market share, funding structure, key success drivers and key dependencies.

Combining this analysis of the sources of profitability of their business model and their reference scenario, institutions should make projections of their risk-adjusted profitability and some other meaningful metrics (including environmental metrics) for their various activities over a horizon of at least 10 years. To challenge the resilience of their strategy, institutions should reproduce the projections made on the basis of their reference scenario with the set of alternative scenarios.

Institutions should break down the analysis into several time horizons, while ensuring consistency between the different horizons. When doing so, they should be able to perform relatively more precise projections over a short-term horizon (e.g. below five years). As the time horizon lengthens, institutions may use ranges on the expected performance of their strategy and on the other key metrics.

For resilience analysis, institutions should use a constrained dynamic portfolio assumption limiting the changes within their main portfolios to those provided for in their existing strategy. In particular, institutions should ensure that their projections are aligned with the targets set in their plan in accordance with Article 76(2) of Directive 2013/36/EU. As a complement, institutions may use a full dynamic portfolio assumption that incorporates both the anticipated evolutions of environmental factors and their expected response to those evolutions.

Resilience analysis should provide institutions with an assessment of the viability of their business model and the sustainability of their strategy under each of the scenarios tested. Institutions should consider the findings from the full range of scenarios and not only focus on those of middle range scenarios (i.e. scenarios that deviate only moderately from their reference scenario). As a result, the implementation of a resilience analysis should support the institution in assessing and, where necessary, adjusting its strategy (including its transition plan) to ensure its resilience to alternative adverse scenarios. FINAL REPORT ON GUIDELINES ON ENVIRONMENTAL SCENARIO ANALYSIS