Ensuring resilience in an uncertain world

Frank Elderson, Member of the Executive Board of the ECB and Vice-Chair of the Supervisory Board of the ECB, delivered a keynote speech at the ECB-Bank of England Conference on supervising climate risk in a non-linear world.

He highlighted the importance of understanding and managing climate and nature (C&N) risks in an increasingly complex, interconnected, and uncertain environment. Elderson emphasized that traditional risk management relies on stable relationships and historical data, which are less applicable in a world characterized by non-linear dynamics and radical uncertainty.

He outlined a framework distinguishing between known knowns, known unknowns, and unknown unknowns. Progress has been made in quantifying and managing known knowns, such as physical damages and transmission channels. However, many risks remain uncertain, especially future tipping points and compound events, which require scenario analysis and continuous improvement.

Scenario analysis, including climate scenarios from NGFS, helps explore plausible futures but has limitations due to feedback loops and feedback effects not fully captured by models. Elderson stressed the importance of understanding scenario limitations, applying expert judgment, and evolving scenarios to address deep uncertainties.

He discussed the concept of radical uncertainty, where future states and interactions are unknown, and emphasized building resilience proactively. This includes maintaining capital, liquidity, operational capacity, and strategic flexibility, as well as developing effective reaction functions, risk mitigants, and climate adaptation investments.

Elderson noted that the challenges of climate and nature risks are relevant to other macro trends such as technological innovation, demographic change, and geopolitical risks. These trends share a common denominator: uncertainty about timing, impact, and transmission channels, requiring an interdisciplinary and proactive risk management approach.

He concluded that modern risk management must go beyond measurement to include preparation and resilience-building. The conference provides an opportunity to deepen understanding across these fronts and strengthen the financial system’s capacity to withstand shocks.

For more details, visit the original source: ECB Keynote Speech.