ECB climate stress test to include 2040 ‘hot house’ scenario

January 19, 2022|Written by Graham Caswell|European Central Bank

Upcoming European Central Bank (ECB) climate stress tests of financial institutions will include a scenario for 2040 in which the effects of global heating occur much faster than previously assumed, Bloomberg has reported. Citing unnamed sources familiar with the testing exercise, the article says the scenario will include “extreme physical impacts” that would shrink European economic output by around 8%.

The new scenario is similar to the ’hot house world’ one envisaged for 2080 which was developed by the Network for Greening the Financial System and outlined in last year’s ECB economy-wide stress test. The acceleration of this potential future by four decades reflects growing fears that governments might not take adequate steps to reduce the emissions that cause climate change.

The ECB’s climate risk stress test will require lenders to report on a common set of climate risk metrics, including the volume of greenhouse gas emissions they finance. Banks will also be required to assess their exposure to short-term physical and transitional climate risks, and to evaluate their response to a series of transition scenarios.

The ECB published the methodology for the assessment last year, and will conduct the exercise between March and July 2022. Part of the second stage of the ECB’s climate plan, it will consist of three modules: an assessment of banks’ climate stress test capabilities; a peer benchmark analysis of climate risk metrics; and a ‘bottom-up’ stress test focusing on transition and physical climate risks. Banks will be required to assess the financial effects of extreme weather events over the next year and of a sharp increase in the price of carbon over the next three years.

The ECB sent banks the underlying scenarios earlier this month, along with questionnaires reviewing preparedness for the materialisation of climate risk.

Billed as a learning exercise, expectations for the results of the assessment are low. A ECB study in 2021 of 112 European banks found that none of them is close to being fully aligned with the ECB’s climate and environmental risk management guidelines. Meanwhile, a recent Bloomberg survey of 20 major European banks found near-universal agreement that the banking sector will not meet ECB guidelines in 2022.

This page was last updated January 19, 2022

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