The European Central Bank (ECB) published results of the climate risk stress test, for 2022, among the significant institutions. The results show that banks do not yet sufficiently incorporate climate risk into their stress-testing frameworks and internal models, despite the progress made since 2020.
The stress test, which is a part of the wider climate roadmap of ECB, was a learning exercise for both banks and supervisors to assess the sector’s preparedness for managing climate risk and identifying best practices for dealing with this risk effectively. About 104 significant banks participated in this test, which had three modules. Through these modules, banks provided information on their climate stress-testing capabilities, reliance on carbon-emitting sectors, and performance in different stress test scenarios over several time horizons:
- The results of the first module show that nearly 60% of the banks do not yet have a climate risk stress-testing framework. Most banks do not include climate risk in their credit risk models while only 20% consider climate risk as a variable when granting loans.
- The second module of the test found that, on aggregate, almost two-third of banks’ income from non-financial corporate customers stems from greenhouse-gas-intensive industries.
- Under the third module, findings of the bottom-up stress test, which was limited to 41 directly supervised banks, show that the vulnerability of banks to a drought and heat scenario is highly dependent on sectoral activities and the geographic location of their exposures. In terms of long-term projections under different climate risk scenarios, the results show that an orderly green transition translates into lower losses than disorderly or no policy action. Banks lack robust strategies, other than the tendency to reduce exposures from the most polluting sectors and to support lower-carbon-emitting businesses.
While acknowledging the many challenges banks are facing with regard to climate risk stress testing, the exercise showed that in each of the assessed areas, at least some of the banks were able to address the challenges in a satisfactory manner, suggesting that it is possible for the industry to raise the bar across all of the areas assessed. ECB also published a presentation on the results of this exercise and set out recommendations to banks. In general, ECB plans to follow up on the findings with bank-specific recommendations and guidance on best practices in climate stress testing. The main focus will be on helping banks to build their internal climate risk stress-testing frameworks and overcome the current challenges. All participating banks are expected to receive individual feedback to take action accordingly, in line with the set of best practices that ECB will publish in the final quarter of 2022.
- Press Release
- Climate Stress Test Results (PDF)
- Presentation on Climate Stress Test (PDF)
- FAQs for Climate Stress Test
Keywords: Europe, EU, Banking, Stress Testing, Climate Change Risk, Climate Stress Test, ESG, Net Zero Transition, Lending, ECB
Dr. Denton provides industry leadership in the quantification of sustainability issues, climate risk, trade credit and emerging lending risks. His deep foundations in market and credit risk provide critical perspectives on how climate/sustainability risks can be measured, communicated and used to drive commercial opportunities, policy, strategy, and compliance. He supports corporate clients and financial institutions in leveraging Moody’s tools and capabilities to improve decision-making and compliance capabilities, with particular focus on the energy, agriculture and physical commodities industries.
Douglas W. Dwyer leads Corporate Credit Research in Predictive Analytics. This group produces credit risk metrics of small businesses, medium sized enterprises, large corporations, financial institutions, and sovereigns worldwide. The group’s models are used by banks, asset managers, insurance companies, accounting firms and corporations to measure name specific credit risk for a wide variety of purposes. We measure credit risk using information drawn from financial statements, regulatory filings, security prices, derivative contracts, behavioral and payment information. For each asset class, the methodology is developed based on the available information for each obligor. <br><br> Current projects include developing a climate adjusted probability of default and incorporating ESG factors into credit analytics. We also are developing an approach to produces comparable PDs across asset classes that opportunistically uses whatever information is available. <br><br> Prior to working at Moody’s Analytics, Dr. Dwyer was a Principal at William M. Mercer, Inc., in their Human Capital Strategy practice. Dr. Dwyer earned a Ph.D. in Economics at Columbia University and a B.A. in Economics from Oberlin College.
Previous ArticleDanish FSA Designates SIFIs, Issues Other Regulatory Updates
Next ArticleIOSCO Sets Out Crypto-Asset Roadmap for 2022-23
The Australian Prudential Regulation Authority (APRA) has published the findings of its latest climate risk self-assessment survey conducted across the banking, insurance, and superannuation industries.
The French Prudential Supervisory Authority (ACPR) published a notice related to the methods for calculating and publishing prudential ratios under the Capital Requirements Directive (CRD IV) and the minimum requirement for own funds and eligible liabilities (MREL).
The Financial Stability Institute (FSI) of the Bank for International Settlements recently published a paper proposing a framework for classifying financial stability regulation as either entity-based or activity-based.
The European Insurance and Occupational Pension Authority (EIOPA) published the risk dashboard based on Solvency II data and the final version of the application guidance on climate change materiality assessments and climate change scenarios in the Own Risk and Solvency Assessment (ORSA).
The European Banking Authority (EBA) and the European Central Bank (ECB) published their responses to the consultations of the International Sustainability Standards Board (ISSB) and the European Financial Reporting Advisory Group (EFRAG) on sustainability-related disclosure standards.
A Consultative Group on Risk Management (CGRM) at the Bank for International Settlements (BIS) published a report that examines incorporation of climate risks into the international reserve management framework.
The European Banking Authority (EBA) published the final guidelines on liquidity requirements exemption for investment firms, updated version of its 5.2 filing rules document for supervisory reporting, and Single Rulebook Question and Answer (Q&A) updates in July 2022.
The European Insurance and Occupational Pensions Authority (EIOPA) published Version 2.8.0 of the Solvency II data point model (DPM) and XBRL taxonomy.
The European Union published, in the Official Journal of the European Union, an opinion from the European Economic and Social Committee (EESC); the opinion is on the proposal for a regulation to amend the Capital Requirements Regulation (CRR).
HM Treasury published a draft statutory instrument titled “The Financial Services (Miscellaneous Amendments) (EU Exit) Regulations 2022,” along with the related explanatory memorandum and impact assessment.