ECB releases results of economy-wide climate stress test

September 23, 2021|Written by Graham Caswell|European Central Bank

The European Central Bank (ECB) has released the results of its economy-wide climate stress test, examining the impact of climate change on millions of firms and the associated exposure of eurozone banks. The study found the costs of climate change and associated weather events far outweighs the costs of transitioning to a low-carbon economy.

This is the first wide-scale granular analysis of physical climate risks over a 30-year time horizon, analysing the impacts on over four million firms worldwide and 1,600 euro area banks under three different climate policy scenarios.

The study is based on an unprecedented dataset of financial and climate information on the individual companies and banks examined. A physical climate risk score was assigned to each firm matched to individual company addresses. In addition, the carbon intensity of industrial sectors was used as a proxy to estimate climate-related transition risk.

The stress test also examined how the financial effects of climate change on individual companies would translate into changes in bank-level vulnerability to climate risk. Mitigators and amplifiers of climate risk, including rising insurance premiums and potential loss of coverage, were also integrated into the assessment.

Incorporating scenarios developed by the Network for Greening the Financial System, the study looked at the effects of climate change on the firms and banks studied under an orderly transition, a disorderly transition, and a disastrous “hothouse world” future.

The exercise found large geographical differences in the type and intensity of climatic effects: flooding is the primary risk in the north and east of the eurozone, while heat stress and wildfires affect southern areas. Physical climate risk is concentrated in certain sectors, with agriculture, water supply, electricity and gas, and mining particularly at risk.

The study also shows the high costs of failing to act to reduce emissions and mitigate climate change. Materialisation of the worst-case scenario would reduce Europe’s GDP by 10% and lead to a 30% rise in corporate defaults, it finds – far beyond the costs of a low-carbon transition.

“The short-term costs of transition pale in comparison with the costs of unfettered climate change in the medium to long term,” it concludes. “In the absence of climate policies, banks’ expected losses would continue to increase non-linearly over time due to climate change’s irreversible nature.”

Previewed by vice-president Luis de Guindos in March, the stress test is a major part of the first milestone in the ECB’s climate plan, along with the adaptation of macroeconomic models to better reflect the effects of climate change. Following this data-gathering exercise, the second step will be to assess the ECB’s own exposure to climate risks and to perform more detailed stress tests of financial firms.

The climate exposure of individual banks will be assessed in a supervisory climate stress test in 2022.

This page was last updated September 24, 2021

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