Credit ratings, research, and risk analysis provider Moody’s Investors Service announced the release of a report today, assessing the expected impact of climate change and the transition to a low-carbon economy on banks’ loan portfolios, and warning of significant potential losses, particularly if the banks fail to reduce their climate exposure.

For the report, Moody’s explored three climate scenarios, based on previous work done by the European Central Bank (ECB), assessing the expected impacts on four European banks with varying levels of climate exposures based on carbon-intensity in their lending, and to sectors with different levels of vulnerability to physical and transition risk.

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The study found that under the most extreme “hot house” scenario, under which delayed transition policies lead to extremely high physical damage, all of the banks would experience significant hits to profitability, with loan losses in some cases growing more than 20% from the baseline scenario of limiting global temperature increase to 1.5 degrees. Overall, despite the different levels of exposure for each bank, the analysis found that differences across banks’ individual loan portfolios will have less impact on loan losses than the choice of climate scenario.

While highlighting how damaging climate change could be to banks’ performance, Moody’s did note that banks’ actions to reduce exposure over the 30-year horizon of the analysis could help mitigate the extent of the losses.

Jorge R. Valez, Senior Vice President at Moody’s, said:

“Our analysis shows that climate risk is likely a key determinant of banks’ loan quality and creditworthiness. It also highlights some differences between banks in terms of their vulnerability to the various climate scenarios and their own carbon exposures. Loan losses could be around 20% higher under the most extreme climate scenario.”