This paper is directed to the financial community and focuses on the financial risks associated with climate change. It, specifically, addresses the estimate of climate risk embedded within a bank loan portfolio. During the 21st century, man-made carbon dioxide emissions in the atmosphere will raise global temperatures, resulting in severe and unpredictable physical damage across the globe. Another uncertainty associated with climate, known as the energy transition risk, comes from the unpredictable pace of political and legal actions to limit its impact. The Climate Extended Risk Model (CERM) adapts well known credit risk models. It proposes a method to calculate incremental credit losses on a loan portfolio that are rooted into physical and transition risks. The document provides detailed description of the model hypothesis and steps. This work was initiated by the association Green RWA (Risk Weighted Assets). It was written in collaboration with Jean-Baptiste Gaudemet, Anne Gruz, and Olivier Vinciguerra (cerm@greenrwa.org), who contributed their financial and risk expertise, taking care of its application to a pilot-portfolio. It extends the model proposed in a first white paper published by Green RWA (https://www.greenrwa.org/).
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