2024, Vol. 7, Issue 2

author(s)
Oladapo Olatinsu

abstract
Climate change and geopolitical instability have emerged as critical systemic threats to global financial stability, compelling regulators and financial institutions to reassess the adequacy of traditional stress testing and scenario analysis frameworks. While such tools have been foundational in post-crisis prudential regulation, their adaptation to climate-related and geopolitical risks remains uneven, with significant methodological, data, and governance challenges. This review examines the evolution of stress testing from credit and market risk applications to its integration with environmental, social, and geopolitical risk factors. Drawing upon frameworks developed by the Basel Committee on Banking Supervision, the Network for Greening the Financial System (NGFS), the International Monetary Fund (IMF), and national regulators, the paper evaluates whether current regulatory models sufficiently capture the complexity, nonlinearity, and long-horizon impacts of climate and geopolitical shocks. The analysis highlights methodological innovations, including macro-financial linkages, cross-border contagion modeling, and tail-risk scenario design, while identifying persistent gaps in scenario plausibility, temporal scope, and integration into supervisory decision-making. Case studies from the European Central Bank, Bank of England, and stress testing exercises in emerging markets illustrate both promising practices and structural deficiencies. The review concludes with policy recommendations to enhance regulatory readiness through harmonized scenario design, improved data granularity, forward-looking risk metrics, and the embedding of climate-geopolitical risk analysis into macroprudential policy.