ECB launches climate risk stress test

January 28, 2022|Written by |European Central Bank

The European Central Bank (ECB) has formally launched its first climate risk stress test of eurozone banks. The bank has also published details of the macrofinancial scenarios against which it expects banks to assess their preparedness for physical and transition climate risks.

Intended as a learning exercise for both banks and ECB supervisors, the exercise consists of a questionnaire on banks’ climate stress test capabilities, a peer benchmark analysis and the stress test itself. Only the largest 115 institutions will be required to provide their own stress test assessment and projections.

The stress test will not directly impact capital through Pillar 2 guidance, but “could indirectly impact Pillar 2 requirements through the Supervisory Risk and Evaluation Process scores”, the ECB said.

The scenarios to be used are based on those developed by the Network for Greening the Financial System, and include transition risks from policies aimed at decarbonising the economy, as well as physical risks such as from extreme weather events. Although the published scenarios do not include an expected 2040 ‘hothouse’ future, banks will be expected to assess the impact of present day extreme flooding and heat events.

The ECB published the methodology for the stress test last year along with the stress test templates. Banks will submit their templates from March and the ECB expects to publish aggregate results in July 2022.

Speaking about the testing exercise at a recent ECB civil society seminar, board member Frank Elderson addressed concerns about the lack of climate-related data available to banks. “Of course we are looking at a very imperfect data set,” he said. “What we have decided very clearly is that we are not going to wait until the data is perfect, because we cannot – the matter is too urgent.”

Urging banks to work with the data they do have and to use proxies where they don’t have data, Elderson was direct. “Risks don’t go away because we don’t have data. You could even argue that because of the lack of data the risks are even bigger, because we don’t see them coming.”

The launch of the ECB’s stress test follows the publication of binding environmental standards for banks by the European Banking Authority (EBA), an independent EU Authority which works to ensure effective and consistent prudential regulation and supervision across the European banking sector. The new EBA standards on Pillar 3 disclosures on environmental, social and governance risks include comparable disclosures and KPIs, such as new green asset and taxonomy alignment ratios.

This page was last updated January 28, 2022

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