STORY HIGHLIGHTS

• A stress testing methodology and tool were recently developed to ensure that the economic analyses of World Bank projects properly consider climate and disaster risks.

• When applied to a transport project in India, the methodology demonstrates that the project is robust to even highly pessimistic climate and disaster scenarios.

• If deployed widely, this methodology and tool could help ensure that all investments are designed to be robust and resilient to climate and disaster risks and thereby promote adaptation to climate change.

Climate stressors such as temperature increases, sea level rise, water scarcity, and extreme weather events including droughts, hurricanes and floods, are increasingly posing risks to the health, livelihoods, and wellbeing of households and communities. They disrupt critical services, reduce agricultural productivity, and destroy infrastructure and dwellings with increasing frequency. To minimize the effect on people’s wellbeing, these impacts need to be considered and integrated in all investments and projects, regardless of their sector, nature, and financing. Ideally, no building, factory, transport infrastructure, or any other asset, should be designed and built without considering disaster and climate risks.

This applies particularly to World Bank projects: to maximize development benefits, it is critical to ensure that our investments are robust, throughout their lifetimes, to a changing climate. The World Bank Group’s newly launched Climate Change Action Plan 2021-2025starts from the premise that climate and development need to be integrated. To help align climate and development, the newly launched Resilience Ratings System provides a simple approach to measure and disclose the extent to which adaptation and resilience considerations have been integrated into project design. The Resilience Rating System is currently being piloted in a number of investment projects supported by the International Development Association, the World Bank’s fund for the poorest countries.

The Resilience Rating System provides a rating from C through to A+ along two complementary dimensions: (1) the resilience of the project design – or the robustness of project design to disaster and climate risks, and the confidence the project will perform as expected in spite of these risks; and (2) the resilience through project outcomes – or the project’s broader contribution to building the climate resilience of beneficiaries. These two dimensions are complementary but different. In particular, all projects should be made resilient to disaster and climate risks, while not all projects need to boost resilience (there are many other valid development outcomes).

“To help align climate and development, the newly launched Resilience Ratings System provides a simple approach to measure and disclose the extent to which adaptation and resilience considerations have been integrated into project design.”

To achieve an “A” rating in the resilience of the project design dimension, projects are required to demonstrate that a climate and disaster risk stress test has been incorporated in the project’s economic and financial analysis. Projects are also required to report on how, after risk reduction measures are included, residual risks do not make the project economically or financially unviable (or they at least must disclose the existence of any residual risk).

In this interview, World Bank Climate Change Lead Economist Stéphane Hallegatte and Senior Climate Change Specialist Veronique Morin explain how the climate risk stress testing methodology can support project teams by identifying potential climate and disaster risks to a project and inform decision makers on project robustness.

What is the history behind the Risk Stress Test methodology? What is the methodology designed to do?

The Resilience Rating System has been piloted in more than 20 projects. Early results  have demonstrated that incorporating a climate and disaster risk stress test is far from straightforward. To help teams perform such a stress test, the World Bank just released a new report, Integrating Climate Change and Natural Disasters in the Economic Analysis of Projects, which provides a methodology – and a tool – to perform a disaster and climate stress test.

Because future changes in climate conditions are highly uncertain, the methodology does not recommend predicting a revised net present value or rate of return. In particular, for projects with long lifetimes, uncertainties are too large and results would be overdependent on assumptions and hypotheses, and risk creating overconfidence.

Instead, the methodology suggests to perform a stress test as part of a project’s economic analysis using various scenarios ranging from the most optimistic to the most pessimistic, and to identify the conditions under which the project may fail, as well as the consequences in case of failure. A reporting template is then proposed to help decision makers assess the level of residual risks, and therefore the project’s attractiveness and economic feasibility.

Practically, the methodology is designed to highlight the risks to project outcomes and evaluation criteria (such as net present value and benefit-to-cost ratio) over long time horizons, in multiple scenarios and accounting for risks along three dimensions:

• Changes in average climate conditions (e.g., temperature, precipitation);
• Impacts from natural disasters, with historic frequency and intensity (e.g., hurricanes, floods, wildfires); and
• Changes in the occurrence of future disasters due to climate change.  

“Early results  have demonstrated that incorporating a climate and disaster risk stress test is far from straightforward.”

How can the methodology be implemented?

The report provides step-by-step guidance for considering and incorporating climate risk stress testing into a project’s economic analysis, and general and sector-specific climate and disaster information resources to support the analysis. To assist with the implementation of the stress testing, an accompanying Excel-based Risk Stress Test (RiST) Tool has been developed to illustrate how the three components of climate and disaster risks can be incorporated in a project’s economic analysis, how climate and disaster impacts can be reflected in components of project costs and benefits, how decision metrics can be evaluated under alternative climate scenarios, and how key assumptions and inputs (such as the discount rate) may change the results of the analysis. Moreover, the tool can help determine threshold conditions under which a project may become economically undesirable and thereby help project teams identify possible risk reduction measures. A series of short one to three-minute training videos are provided to demonstrate the applicability of the RiST tool.

Are there any examples of how the methodology has helped project teams identify possible climate and disaster risks and evaluate project robustness?

Illustrative applications are provided for projects in energy, transport, water infrastructure, and agriculture. One of these projects is the  Integrated Transport Project in the state of Meghalaya, India. This project aimed to improve transport connectivity and efficiency and modernize transport sector management. Given that Meghalaya is in one of the wettest regions in the world, the analysis accounted for climate risks by estimating the impact on the costs and benefits of the project of changes in average conditions (i.e., temperature and rainfall patterns) and natural hazards (i.e., landslides and flooding), considering current and future frequency and intensity. The analysis demonstrated that even with a pessimistic baseline scenario (assuming delays in implementation and increase in costs) and a high-end climate impact scenario, the project is still anticipated to generate a positive Net Present Value, even though the expected net benefits can be halved by disaster and climate risks.

Beyond the result of the analysis, the implementation of the stress test guided the team in its exploration of possible disaster and climate risks and provided important information to help assess the project’s economic feasibility, therefore contributing to proper climate and disaster risk management and reduction, and increasing our confidence in the project’s ability to deliver its expected results in spite of today’s and tomorrow’s climate risks. 

Source: World Bank