The European Central Bank (ECB) published results of its economy-wide climate stress test, which aimed to assess the resilience of non-financial corporates and euro area banks to climate risks. The results show that firms and banks benefit from adopting green policies early on, to foster the transition to a zero-carbon economy. The short-term costs of the transition pale in comparison to the costs of unfettered climate change in the medium to long term. The early adoption of policies to drive the transition to a zero-carbon economy also brings benefits in terms of investing in and rolling out more efficient technologies. The results and methodology of this exercise are expected to inform the 2022 climate stress test for banks under the ECB supervision.
The results of the economy-wide climate stress test show that, although the effects of climate risk would increase moderately, on average, until 2050 if climate change is not mitigated, they would be concentrated in certain geographical areas and sectors. When comparing the effects of transition and physical risks, the outcomes indicate that physical risk would be more prominent in the long run, especially if policies to transition toward a greener economy were not introduced. The results also suggest that for the corporates and banks most exposed to climate risks, the impact would be very significant, particularly in the absence of further climate mitigating actions. The anticipated impact on banks in terms of losses would mostly be driven by physical risk and would be severe over the next 30 years. These final climate stress test results are in line with the preliminary results published in March 2021 and complement the findings by including assessments of banks’ resilience to climate risks through loans and security and equity holdings.
The exercise tested the impact of climate change on more than four million firms worldwide and 1,600 euro area banks under three different climate policy scenarios. It used climate-specific scenarios to project climate and macroeconomic conditions over the next 30 years, along with a comprehensive dataset that combines climate and financial information for millions of companies worldwide. A novel set of climate-specific models were developed to capture the direct and indirect transmission channels of climate risk drivers for firms and banks. This stress test exercise marks the first step in the climate roadmap of ECB. The results and methodology of this exercise will inform the 2022 supervisory climate stress test for banks that are under direct supervision of ECB. The results and methodology of this exercise will also feature in the climate stress test of the Eurosystem balance sheet, which is being planned for the first quarter of 2022. Going forward, the current climate stress-testing framework is expected to be updated and extended to further improve the robustness and completeness of further exercises:
- The climate stress-test methodology and results will be updated to incorporate the new Network for Greening the Financial System (NGFS) scenarios that were published in June 2021.
- The static balance sheet assumption will be relaxed to allow for second-round effects and a feedback loop between banks and the real economy arising from dynamic reactions by banks to changes in their counterparties’ creditworthiness.
- The methodological setup could also be extended to incorporate the effects of transition and physical risks on banks’ retail portfolios and expanded to assess the effects on other financial intermediaries such as asset managers and insurance companies.
Keywords: Europe, EU, Banking, Climate Change Risk, Stress Testing, Climate Stress Test, Systemic Risk, ESG, ECB
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