Banks fail ECB climate risk review

Banks fail ECB climate risk review

Yesterday, the European Central Bank published the first stress test focusing on the analysis of climate risks facing banks, with an expected conclusion. “Banks are still not sufficiently taking climate risk into account in their stress testing frameworks and internal models, even though they have made progress since 2020.”

The truth is that only 49 of the 104 entities, 47% that were the subject of the study, passed the demanding analysis process imposed by the regulator. For them, a risk of around 70,000 million euros has been detected. “There is an urgent need for credit institutions in the euro area to step up their efforts to measure and manage climate risk by eliminating the current data gaps and adopting the good practices already applied in the sector,” said Andrea Enria, Chairman of the Supervisory Board of the ECB. .

Only 20% of banks take the environment into account when granting loans

The consequences of this failure will not go beyond this advice. There will not be, as is the custom with the stress tests carried out on European banks since the 2008 crisis, capital penalties or any other type. Not even public information on the results obtained by each entity. Because, as the ECB itself reminds us, this was a “learning” exercise for everyone.

The objective is for the sector to learn to integrate into its risk forecasting models the impact of bad weather from climate change, such as major droughts, floods, heat or cold waves, as was the case with snowfall Philomena .

A long-term orderly green transition would generate fewer losses than a short-term disorderly transition

Of course, it’s not easy. According to financial sources, there is not even a unified model to quantify these impacts, which are very different depending on the sectors, the geographical areas in which the entities are exposed, etc. It is this complexity that has prevented the vast majority from taking the test. “This exercise is a fundamental step in our journey towards a financial system that is more resilient to climate risk. We expect banks to take decisive action and put in place strong climate stress testing frameworks in the short to medium term,” said Frank Elderson, Vice Chairman of the Supervisory Board. The ECB analyzed, on the one hand, the capacity of each entity to carry out this type of test. Whether or not you have enough tools, people, data…

Result: 60% of entities do not yet have a climate risk stress test framework. Most do not even include this notion in their credit risk models, and only 20% take it into account as a variable when granting loans.

ECB acknowledges its first climate stress test is a ‘learning’ exercise

Secondly, the stress test analyzed the dependence of each entity’s accounts on customers belonging to carbon-intensive sectors. At this stage, the ECB recommends greater interaction with clients to clarify the risks. For example, a client in the energy sector does not have the same risk if its activity is in the coal market than in the wind turbine market. While the entities present in Spain are more exposed to drought and the entities of Central Europe to floods.

Finally, the ECB asked the 41 entities it supervises directly to project losses in the face of extreme weather events and in transition scenarios with different time horizons. An extreme drought and a heat wave in which productivity drops are generated in the most exposed sectors such as agriculture or construction, in addition to productivity losses. In the second case, the floods reflect the deterioration of mortgage guarantees and payment defaults.

The aforementioned 70,000 million losses would come as part of a disorderly and short-term green transition. Although the ECB itself warns that this “amount considerably underestimates the real climate risk” due to limited data availability and that the models reflect the climate impact in a “rudimentary” way. For this reason, it does not give a precise figure on the long-term impact, even if it recognizes that an orderly green transition in the long term would generate fewer losses than a disorderly transition in the short term and even that the option to do nothing about climate change.


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