Unpacking the Complexity of Climate Risk Stress Testing (CRST): A Strategic Guide for Financial Institutions in Indonesia

The global financial system is undergoing a paradigm shift. Regulators worldwide now recognize that climate change is no longer just an environmental issue, but a primary source of systemic financial risk. This push stems from the increasing frequency and intensity of extreme weather events, as well as the profound economic shifts required for the transition to a low-carbon economy.  

In Indonesia, this global momentum has been translated into concrete regulatory action by the Financial Services Authority (OJK). The issuance of the Climate Risk Management & Scenario Analysis (CRMS) guide and the launch of a pilot Climate Risk Stress Testing (CRST) exercise for the banking sector mark a new era in prudential supervision. The OJKs stated goal is to enhance the banking sectors capacity to assess climate impacts, in order to safeguard financial stability and support a sustainable transition. This shifts the conversation from voluntary "green finance" initiatives to structured and mandated risk management.  

This rapid formalization of CRST by the OJK reflects a global "regulatory catch-up," where climate risk is now being elevated to the same level of importance as traditional prudential risks like credit, market, and liquidity risk. This process is not merely an additional reporting exercise; it is a fundamental redefinition of what constitutes sound risk management in the 21st century. The global regulatory trail shows a clear pattern: it begins with raising awareness and voluntary frameworks , followed by the development of standardized scenarios by bodies like the Network for Greening the Financial System (NGFS). Pioneering regulators such as the European Central Bank (ECB) and the Bank of England (BoE) then launch "exploratory" or "learning" exercises. The OJK is now following this proven path, mandating CRST for major Indonesian banks after an initial pilot phase. The language used by regulators, such as integrating CRST into the Supervisory Review and Evaluation Process (SREP) and assessing its impact on capital, confirms its elevation to a core prudential concern. The implication is clear: Indonesian banks must treat CRST not as a temporary project, but as a permanent and integral component of their Enterprise Risk Management (ERM) Framework, demanding sustained investment in governance, data infrastructure, and expertise—akin to the implementation of the Basel Framework.  

Understanding the Foundations of CRST: Physical and Transition Risk

To effectively conduct CRST, financial institutions must first understand the two main pillars of climate risk and how they translate into tangible financial risks.

Physical Risk

This risk stems from the direct impact of climate change on the physical world. Physical risk is divided into two main categories:

• Acute Risk: These are shocks driven by specific events, such as floods, hurricanes, droughts, and wildfires. These events cause direct damage to physical assets (e.g., property, infrastructure, agricultural land), disrupt business operations, and sever supply chains. For banks, this translates to damaged or devalued collateral, lower asset valuations, and an increased likelihood of default from affected borrowers.  

• Chronic Risk: These are long-term, gradual shifts in climate patterns, such as rising sea levels, sustained heatwaves, and changing rainfall patterns leading to water scarcity. These risks slowly erode asset values, decrease agricultural productivity, and can render entire regions economically unviable over time.  

Transition Risk

This risk arises from the societal and economic adjustments towards a low-carbon economy. Transition risk is driven by:  

• Policy Changes: The implementation of carbon taxes, emissions trading schemes, and stricter environmental regulations.

• Technological Shifts: The rise of renewable energy and electric vehicles rendering fossil fuel infrastructure obsolete.

• Changes in Market Sentiment and Consumer Preferences: Increasing demand for sustainable products and services and pressure from investors for decarbonization.  

The primary danger of transition risk is the creation of "stranded assets"—assets that suffer from premature write-downs or devaluation. This is particularly relevant for carbon-intensive sectors like coal mining, oil and gas, and certain manufacturing industries.  

Transmission Channels to Financial Risk

The crucial step in CRST is understanding how these physical and transition risk drivers flow into the traditional financial risk categories that banks are already familiar with:

• Credit Risk: This is the most direct transmission channel. Climate risk can increase a borrowers Probability of Default (PD) by reducing their revenues or increasing their operational costs. Simultaneously, it can decrease the value of collateral, which in turn increases the Loss Given Default (LGD).  

• Market Risk: A sudden repricing of securities (stocks, bonds) from companies highly exposed to climate risk can lead to significant market losses in a banks trading book.  

• Operational Risk: Physical risks can directly disrupt a banks own operations (e.g., damage to branches or data centers). Meanwhile, both types of climate risk can trigger litigation and reputational damage.  

• Liquidity Risk: A severe climate-related shock could trigger a sudden demand for liquidity as market confidence falters or the banks reputation is damaged.  

The conventional separation of physical and transition risks is often an oversimplification. In reality, these two risks can interact and reinforce each other, creating complex "compound risks". A robust CRST framework must account for these interactions, not model them in isolation. For example, a series of severe floods (physical risk) in a key agricultural region could trigger sudden and stringent government policies on water use and land management (transition risk), thus compounding the economic shock. Conversely, a disorderly transition (e.g., a sudden, high carbon tax) could weaken carbon-intensive industries, reducing their capacity to invest in climate adaptation measures and thereby making them more vulnerable to future physical risks. Therefore, a sophisticated CRST for an Indonesian bank cannot simply model a flood in one scenario and a carbon tax in another. It must be able to develop scenarios where, for instance, delayed national transition policies exacerbate the financial impact of a major typhoon. This demands a far more nuanced and integrated modeling approach.  

Global and Local Frameworks: From NGFS to OJK Guidance

The implementation of CRST in Indonesia is not happening in a vacuum. The practice is heavily guided by global standards that are then adapted for the unique national context.

The Global Standard: The Network for Greening the Financial System (NGFS)

The NGFS has emerged as the global standard-setter, providing a harmonized analytical framework and a common set of reference scenarios used by over 100 central banks and supervisors, including the OJK. It is crucial to understand that NGFS scenarios are not forecasts. They are plausible, forward-looking  

"what-if" narratives designed to explore a range of possible futures and test the resilience of the financial system under varying degrees of stress. These scenarios are built on integrated assessment models (IAMs) that link climate pathways to economic variables.  

The table below summarizes the NGFS reference scenarios that form the basis for many CRST exercises worldwide.

OJKs Adaptation for the Indonesian Context

As a member of the NGFS, the OJK has strategically adopted this global framework and tailored it to Indonesias national interests and economic vulnerabilities. The primary vehicle for this is the Climate Risk Management & Scenario Analysis (CRMS) Guide, an integrated framework covering governance, strategy, risk management, and disclosure.  

The OJKs implementation is phased and methodical. It began with an initial pilot in 2023 involving 11 banks, which was then expanded to all banks in the Core Capital-Based Bank Group (KBMI) 3 and 4 categories, with a reporting target for 2024. This demonstrates a clear and escalating commitment.  

Crucially, the CRMS guide establishes priority sectors for analysis, reflecting Indonesias unique economic structure and its Nationally Determined Contribution (NDC) targets. These sectors include high-impact areas such as Mining and Quarrying, Electricity Supply, Construction, Transportation and Warehousing, Agriculture, Forestry, and Fishery, as well as the Manufacturing Industry. The framework also mandates specific time horizons for transition risk analysis—short-term (3-year projection), medium-term (2030), and long-term (2040 and 2050)—which align directly with the structure of the NGFS scenarios.  

The OJKs selection of priority sectors is not a random choice, but a strategic decision to test the core vulnerabilities of the Indonesian economy. The chosen sectors, such as mining, agriculture, and forestry, are significant pillars of national GDP, employment, and exports (e.g., coal, palm oil, timber). However, these same sectors are also highly vulnerable to the physical risks prevalent in Indonesia, such as floods, droughts, and forest fires. At the same time, they are the most exposed to global transition risks, such as international carbon pricing, shifting investor sentiment against fossil fuels, and regulations on deforestation-linked commodities. By forcing banks to analyze these specific portfolios, the OJK is effectively stress-testing the resilience of Indonesias core economic engine in the face of climate change. For Indonesian banks, the results of CRST are not just a measure of the banks own health, but also a forward-looking indicator of the health of its core corporate client base.  

Practical Challenges in CRST Implementation

Although the framework is clear, financial institutions face significant operational hurdles in their efforts to implement CRST. Understanding these challenges is the first step to overcoming them.

Key Challenge 1: Data Gaps and Quality

This is universally cited as the biggest challenge. There is a lack of granular, reliable, and forward-looking climate data. This has been a primary finding in every major stress test exercise globally, from the ECB to the BoE, and is a major obstacle for Indonesian banks. The core problem is the scarcity of  

counterparty-level data, including:

• Greenhouse Gas (GHG) Emissions: Especially Scope 3 (value chain) emissions, which are often the largest component for many sectors but are notoriously difficult to measure.  

• Asset Geolocation: Precise location data for corporate facilities and real estate collateral is essential for accurate physical risk modeling but is often unavailable or inconsistent.  

This data scarcity forces banks to rely heavily on proxies and estimations from third-party data providers. This introduces significant uncertainty, makes results less reliable, and hinders comparability across institutions.  

Key Challenge 2: Modeling Complexity

Translating high-level, global NGFS scenario variables (like a global carbon price) into specific, localized impacts on a banks portfolio—a process known as "downscaling"—is highly challenging and lacks a single, standardized methodology. Traditional risk models (e.g., for calculating PD and LGD) are built on historical data. However, climate change is a forward-looking, non-linear phenomenon with no historical precedent, making these models ill-suited for the task. Capturing second-round and feedback effects (e.g., how the collective actions of all banks to de-risk from a sector could trigger a fire sale and amplify the initial shock) is a frontier challenge that most current models cannot yet address.  

Key Challenge 3: Time Horizons and Assumptions

CRST requires very long time horizons (e.g., 30 years to 2050) to meaningfully capture climate impacts. This long-term view clashes with the much shorter business planning, risk management, and loan maturity cycles (often 3-5 years). This makes it difficult to integrate CRST results into immediate business decisions.  

To manage this complexity, initial exercises often rely on a "static balance sheet" assumption, which freezes the composition of the banks portfolio over the entire time horizon. While this is a necessary simplification to get started, it is highly unrealistic and can lead to an overestimation of losses, as it assumes the bank takes no mitigating actions for 30 years.  

However, this "data gap" is not merely a technical hurdle; it is a strategic catalyst. CRST is intentionally designed by regulators to force an improvement in corporate climate disclosures across the market by creating a direct financial incentive (i.e., better loan terms) for companies to provide better data. Banks consistently report that the biggest obstacle is the lack of data from their corporate clients. This forces them to use less reliable proxies, which weakens their analysis. Regulators like the ECB and BoE explicitly state that a primary goal of their stress tests is to push banks to engage more deeply with their clients to obtain this data. Academic research confirms this effect: banks participating in climate stress tests change their lending behavior. They do not just cut ties with "brown" firms; they engage with them more, using the information gathered to support credible transition plans. Thus, the CRST exercise is a powerful mechanism to break the "data deadlock" where firms dont disclose because banks dont ask, and banks dont ask because the data isnt available. The process of the stress test becomes just as important as the results.  

From Stress Test to Strategic Action: Leveraging CRST Results

The true value of CRST lies not in the final loss figures, but in how those insights are used to build a more resilient and profitable institution. Turning CRST from a compliance burden into a strategic tool is the key to unlocking its full potential.

Informing Governance and Strategy

CRST results should be a primary input for the Board of Directors and senior management. The exercise provides a forward-looking view of the business models resilience under various plausible futures. It is a powerful diagnostic tool for identifying hidden risk concentrations. For example, the ECBs stress test revealed that over 60% of banks income came from GHG-intensive industries, a critical strategic vulnerability. This analysis should directly inform the banks long-term strategic planning, potentially leading to a shift away from unsustainable business models.  

Refining the Risk Appetite Framework

CRST results should be used to define and calibrate the banks Risk Appetite Framework (RAF). This means setting explicit quantitative limits and Key Risk Indicators (KRIs) for climate-related exposures. This moves beyond high-level statements and embeds climate considerations into the core of the banks risk management engine.  

Integrating Climate Risk into the Credit Cycle

Insights from CRST must be cascaded down to day-to-day operations. This means embedding climate risk assessment at every stage of the credit lifecycle :  

• Prospecting & Origination: Using climate risk scores to screen new clients, performing enhanced due diligence on high-risk sectors, and requesting new types of data (e.g., transition plans) during the loan application process.  

• Portfolio Management: Actively monitoring the climate risk profile of the entire loan portfolio and using CRST insights to steer the portfolio towards greater resilience.

Driving Capital Allocation and Product Innovation

CRST provides a clear rationale for reallocating capital away from activities with high, unmitigated climate risk, towards opportunities in the green transition. This creates a strong business case for product innovation, such as developing green loans, sustainability-linked bonds, and advisory services to help corporate clients finance their decarbonization efforts. This turns a risk management exercise into a revenue-generating opportunity.  

Moving Beyond Divestment: The Engagement Strategy

A naive response to CRST results is to simply divest from all "brown" assets. However, this is strategically short-sighted and can create negative social outcomes, such as stranding carbon-intensive communities or simply shifting risk to less-regulated entities. A more sophisticated strategy, informed by CRST, is to engage with high-emitting clients, using the banks financial leverage to support and finance their credible transition plans.  

Ultimately, CRST is becoming the new basis for competitive differentiation in banking. Regulators state that initial CRSTs are "learning exercises" with no direct, formulaic capital add-ons. However, they quickly add that qualitative findings are already influencing SREP scores and, consequently, Pillar 2 capital requirements. The BoE has also clearly signaled that future capital implications are being considered. This creates a powerful incentive to develop superior capabilities. A bank that can demonstrate a robust CRST framework signals to regulators and investors that it has superior risk management. Superior capabilities in data analysis and modeling allow a bank to better differentiate between high-risk firms and those with credible transition plans. This enables them to finance the transition of credible firms, capturing a valuable and growing market, while avoiding the high-risk ones. Therefore, investing in CRST capabilities is not a defensive compliance cost; it is an offensive strategic investment. It builds a core competency that will define a banks profitability, cost of capital, and market position in the coming decade.  

Navigating a Resilient Future with BATS Consulting

Climate Risk Stress Testing (CRST) is a complex, data-intensive, and strategically vital evolution in financial risk management. It is no longer an option, but a core component of prudent banking practice in Indonesia, driven by global pressures and a direct mandate from the OJK. Facing significant challenges such as bridging data gaps, mastering modeling complexities, and translating long-term insights into concrete strategy is undoubtedly difficult.

You dont have to face these challenges alone. At BATS Consulting, we understand the complex climate risk landscape, both globally and within the unique context of Indonesia. We dont just help you meet regulatory obligations; we help you build a sustainable competitive advantage.

Our services are designed to turn these challenges into strategic advantages:

• Data Strategy & Quantitative Modeling: Our expert team helps you bridge data gaps with innovative sources, develop robust modeling methodologies to translate NGFS and OJK climate scenarios into concrete risk parameters (PD/LGD), and build a reliable and validatable quantitative framework.

• Risk Integration & Business Strategy: We work with your board and management teams to integrate CRST findings into your Risk Appetite Framework, credit management processes, and long-term business strategy. We help you answer the "so what?" question—turning stress test results into executable action plans for capital allocation and product innovation.

• Capacity Building & Governance: We provide tailored training programs for your board and management teams, ensuring strong climate governance and building the internal capabilities needed to navigate an ever-changing future and meet regulatory expectations.

Dont let the complexity of CRST hinder your growth. Partner with BATS Consulting to transform risk into resilience, and obligation into opportunity. Contact us today for a discussion on how we can help you lead the way to a sustainable financial future in Indonesia.

_____________ Tentang BATS Consulting BATS Consulting adalah firma konsultan strategis terkemuka di Indonesia yang menawarkan solusi menyeluruh di bidang akuntansi, perpajakan, keuangan, hukum, dan keberlanjutan (ESG). Dengan tim ahli berpengalaman internasional dan pendekatan berbasis data, BATS membantu klien dari berbagai sektor untuk mengoptimalkan kepatuhan, efisiensi bisnis, serta strategi pertumbuhan jangka panjang. Layanan unggulan kami meliputi transfer pricing, audit pajak, merger & akuisisi, hingga pengelolaan emisi karbon dan pasar kredit karbon, menjadikan BATS mitra yang terpercaya untuk kebutuhan bisnis modern. Mengusung prinsip "global insight with local relevance", BATS Consulting tidak hanya memberikan solusi yang tepat sasaran, tetapi juga mampu menjawab tantangan regulasi lokal dengan standar internasional. Berlokasi di Jakarta, kami telah menjadi pilihan utama berbagai perusahaan nasional dan multinasional yang ingin meningkatkan daya saing mereka secara berkelanjutan. Apapun tantangan bisnis Anda, BATS hadir sebagai partner strategis yang tangguh dan adaptif untuk mengantarkan Anda pada kesuksesan. Hubungi BATS Consulting:

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