Euro area banks, funds and insurers face material climate-related financial risks, according to a European Central Bank (ECB) study published as part of its bi-annual Financial Stability Review.
The review reveals that a significant share of bank loan exposures to corporations could be subject to high levels of climate-related physical risk. The materialisation of this risk directly affects corporate operations and the physical collateral used to secure loans.
The ECB examined both physical and transition risks to banks and the financial sector, finding risk concentrated in vulnerable banks and specific regions. Insurers play an important role in bank exposure to climate risk, but only a third of climate-related economic losses in the euro area are insured. Climate change is expected to further reduce coverage of climate-related losses, thus increasing risk.
The review also emphasises that inadequate climate risk data prevents the development of strategies to manage and price climate risk, calling for “mandatory, harmonised and auditable disclosure standards.”
There were also more details on the ECB’s ongoing economy-wide climate stress test. Combining firm-level datasets, economic and climatic scenarios, and specifically designed models, this macroprudential exercise clearly shows the short-term costs of implementing climate policies are significantly lower than the much higher costs from natural disasters and climatic changes in the medium to long term.
The report concludes with the warning that “the systemic nature of climate-related risks implies that narrowly mitigating the exposure of one part of the financial system could prompt the transfer of risk to other sectors.” It calls for a system-wide perspective to avoid this trap.
A press release announcing the stability review explained the importance of enhanced climate-related disclosures and data. The review repeatedly calls for “mandatory global reporting standards,” a reference to climate risk assessment and disclosure aligned with the recommendations of the Taskforce on Climate-Related Financial Disclosures (TCFD).
Several countries, including the United Kingdom, have already announced the introduction of mandatory TCFD-aligned climate risk disclosure. There are expectations the United States may soon follow suit.
The ECB’s previous Financial Stability Review, published last November, found that Eurozone banks had increased their lending to carbon-intensive firms since the Paris Agreement was signed in 2015. Think tanks and climate campaigners have called for the introduction of climate-related criteria into the ECB’s corporate bond purchases and collateral framework to reduce this exposure and help mitigate climate change.
This page was last updated May 19, 2021
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