The European Central Bank (ECB) announced plans to extend the use of climate factors in the collateral framework to eligible loans to non-financial corporations, significantly expanding its initiative to adjust the value assigned to assets pledged by banks as collateral for central bank loans, based on their exposure to climate transition risks.

The announcement follows the recent rollout by the ECB of the climate factor, initially applied only to corporate bonds pledged as collateral. At the time, the ECB acknowledged that the immediate effect of the climate factor on banks would be limited, given the limited use of corporate bonds as collateral. The new category, credit claims whose debtor is a non-financial corporation, forms a significantly larger portion of the Eurosystem portfolio.

Initial plans for the climate factor were revealed by the ECB last year, following stress tests performed on the Eurosystem balance sheet, which indicated that the value of financial assets can be directly affected by climate change-related uncertainties, and that an unexpected drop in value caused by a climate shock could result in financial losses for the Eurosystem.

In a post announcing the plans to extend the climate factor, the ECB said:

“Collateral pledged by counterparties in Eurosystem refinancing operations may be exposed to unexpected climate-related transition shocks, such as changes in climate policy, technological developments, shifts in consumer behaviour, litigation and broader macroeconomic adjustments. These factors may affect the value of collateral, including credit claims, at times when the Eurosystem might need to liquidate such assets.”

According to the ECB, the climate factor applied to eligible corporate loans will be based on an asset-level uncertainty score comprised of three key elements, including a sector-level stressor derived from the latest Eurosystem climate stress test, the debtor’s exposure to transition-related uncertainties and the residual maturity of the credit claim. The ECB added that the higher the sensitivity of the collateral to climate uncertainties, the greater the reduction applied to its collateral value, although the maximum additional reduction in the final collateral value will be 5%.

The ECB said that it expects to implement the extension of the climate factor by the end of 2027 at the earliest, with climate factor values to be updated annually.

The ECB added:

“The extension is designed to further strengthen the Eurosystem’s risk management framework by addressing financial uncertainties related to the green transition.”