Pricing climate transition risk in the banking book : A Scope 3 capital pass-through approach

Abstract

This paper proposes a capital-based pricing methodology for banking book loans that embeds Scope 3 emissions and the Partnership for Carbon Accounting Financials (PCAF) attribution standard into a practical transition risk framework for banks. Building on the Scope 3 capital design model of Trevisani et al.,1 the paper adapts the future carbon policy exposure, Climate-Policy-Risk-Weighted-Assets, and climate policy capital (CPC) concepts from trading book derivatives to amortising loan exposures. It shows how a bank can compute a loan-level climate premium by applying CPC as an incremental capital charge to individual facilities and converting it into an interest rate spread via a simple pass-through rule. The framework incorporates financed-emissions attribution in line with PCAF guidelines2,3 and is implemented in a simple, self-contained R framework that produces borrower-specific premia and portfolio views. The resulting tool allows risk managers to integrate climate transition risk into loan pricing and funds transfer pricing in a transparent, scenario-consistent, and operational way, thereby helping institutions prepare their balance sheets for the impact of future climate policy. This article is also included in The Business & Management Collection which can be accessed at https://hstalks.com/business/.