ECB stress test shows economic impact of climate change

March 19, 2021|Written by Graham Caswell|European Central Bank

A groundbreaking stress test shows a potential wave of defaults due to the effects of climate change without a “timely and effective” transition to a greener economy. The test, conducted by the European Central Bank (ECB), examined four million companies worldwide to gauge the exposure of 2,000 eurozone banks to future climate risks.

“Preliminary results from the stress test show that in the absence of further climate policies, the costs to companies arising from extreme weather events rise substantially, and greatly increase their probability of default,” ECB Vice President Luis de Guindos warned.

The exercise is the first of its kind and was conducted by ECB staff using comprehensive internal datasets of millions of companies with data on carbon footprints, bank exposures and other relevant information.

Companies were examined over a 30-year period across three climate scenarios: an orderly transition to a green economy, a disorderly transition with limited physical climate risk, and a “hothouse” world with extreme physical risks. The test’s main objective was to assess the exposure of eurozone banks to future climate risks from the operations and balance sheets of individual companies.

The ECB study included an assessment of physical risk from flooding, wildfires, sea level rise and other climate hazards using data from Four Twenty Seven, Moody’s credit rating agency. Transition risks examined included rising energy prices, technological substitution and rising insurance costs.

This economy-wide stress test is separate from the supervisory climate stress tests for financial institutions scheduled for 2022, which will rely on individual banks’ self-assessment of their exposure to climate change risk.

In his article, published in eight European newspapers, de Guindos said that the initial results of the economic stress test had already shown that climate change represents a major source of systemic risk. He noted that this was true “particularly for banks with portfolios concentrated in certain economic sectors and, even more importantly, in specific geographical areas”.

The most polluting companies, along with those in areas most vulnerable to physical risk, are exposed to up to four times as much climate risk as average firms over the next 30 years.

The final results of the climate stress test are due to be released by July 2021. They will be used to model how banks could shift their exposure away from the riskiest companies and what impact this would have on insurers, non-bank financing companies and the wider economy.

This page was last updated April 26, 2021

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