Results of the 2022 Climate Risk Stress Test of the Eurosystem Balance Sheet

In this blog post, analysts outline the results of the first climate stress test of the Eurosystem’s balance sheets and the next steps for the European Central Bank’s (ECB) stress testing.

The 2022 test exercise reveals that the Eurosystem’s balance sheet is materially exposed to physical and transition risks and that corporate bonds are the primary source of overall climate risk. The findings also show that physical risks substantially outweigh transition risks and are concentrated in certain geographical locations, whereas transition risks are concentrated in specific high-emitting sectors.

The test was conducted as part of the ECB’s commitment to enhance its climate risk analysis and published in its March 2023 Economic Bulletin. The scope of the exercise covered a range of the Eurosystem’s monetary policy portfolios, namely its corporate bonds, covered bonds, asset-backed securities (ABSs) and collateralised credit operations.

The authors outline the ECB’s ongoing commitment to integrate climate change risk into the Eurosystem’s regular risk assessment processes and to continue to enhance its methodologies. These steps will allow the ECB to properly assess the adequacy of existing capital buffers and “modify risk control frameworks and build up financial buffers” in good time.

In line with previous stress tests conducted by the ECB, this exercise used long term scenarios developed by the Network of Central Banks and Supervisors for Greening the Financial System (NGFS) over a 30 year horizon. The 2022 exercise expands upon previous iterations by considering two further short-term scenarios designed by the ECB.

The novel scenarios are a flood risk scenario, covering hazards that could materialise over a one year horizon, and a short-term disorderly transition scenario, which frontloads sharp carbon price increases over a three year horizon.

While the corporate bond portfolio was found to be the main climate risk contributor, the relative risk for both covered bonds and ABSs was greater under the “hot house world” scenario and the flooding risk scenario. As covered bonds and ABSs are frequently secured by real estate, they are particularly vulnerable to transmission of climate risk through physical hazards that impact housing market valuations.