The European Central Bank (ECB) announced today the results of its climate stress test, indicating that banks urgently need to accelerate the incorporation of climate risk into their risk management frameworks, and that banks remain heavily exposed to emissions-intensive industries.
The ECB launched the stress test early this year, aiming to assess banks’ preparedness for dealing with financial and economic shocks stemming from climate risk. The study reviewed information provided by 104 participating banks, assessing their own climate stress-testing capabilities, and their reliance on carbon-emitting sectors. For a subset of the banks, the ECB also asked for information on the impact on their performance under various transition scenarios, taking into account factors including increases in carbon prices, and from physical risks such as flood and severe heat.
The report indicated that while banks have made progress in recent years to incorporate climate risk, significant work remains by most banks to sufficiently measure and manage climate-related risks. Nearly 60% of the banks examined do not yet include climate risk considerations in their stress testing frameworks, and only one-in-five currently consider climate risk when granting loans. The ECB said that banks need to work on improving the governance structures of their stress test frameworks, data availability and on their modelling techniques.
Andrea Enria, Chair of the ECB’s Supervisory Board, said:
“Euro area banks must urgently step up efforts to measure and manage climate risk, closing the current data gaps and adopting good practices that are already present in the sector.”
The test also indicated a need for banks to more clearly define their long-term climate transition strategies, given their significant exposure to high emitting industries. According to the results of the stress test, nearly two-thirds of the banks’ income from non-financial corporate customers is currently earned from sectors considered “GHG-intensive,” well above the relative weight of these industries in the EU economy.
41 banks participated in the study of examination of climate-related performance risk. The banks were asked to consider scenarios based on those prepared by Network of Central Banks and Supervisors for Greening the Financial System (NGFS), reflecting possible future climate policies, and assessing physical risks, including heat, drought and floods, and short and long-term risks stemming from the transition to a greener economy such as increasing carbon prices. The stress test identified potential credit and market losses of €70 billion for the banks under the disorderly and physical risk scenarios, while the ECB noted that this amount “significantly understates” the actual level of risk, as they don’t anticipate any economic downturn from the adverse climate scenarios, don’t yet incorporate sufficient data, and only examined a small subset of banks.
Frank Elderson, Vice-Chair of the ECB Supervisory Board, said:
“This exercise is a crucial milestone on our path to make our financial system more resilient to climate risk. We expect banks to take decisive action and develop robust climate stress-testing frameworks in the short to medium term.”
Click here to view the ECB climate stress test results.