The ECB’s Economy-Wide Climate Stress Test

In this blog post, Luis de Guindos, vice president of the European Central Bank (ECB), outlines an economy-wide climate stress test currently being conducted by the bank.

The stress test will examine four million companies worldwide to gauge the impact of climate events on 2,000 Eurozone banks over a 30-year period, using the carbon intensity of industrial sectors as a proxy for transitional risk. After an overview of systemic climate risk and stress testing, de Guindos describes the main components of the ECB test and shares its preliminary results.

The bank has constructed an unprecedented dataset of financial and climate information for millions of firms, including a forward-looking physical risk score for each firm matched to individual company addresses. The climate stress-test combines this company-level data with aggregate transition and physical risk trajectories from scenarios developed by the Network for Greening the Financial System (NGFS). These include an orderly transition, a disorderly transition, and a calamitous hothouse world scenario. Mitigators and amplifiers of climate risk, such as insurance and insurance premiums, were also integrated into the assessment.

This is the first study of its kind to analyse physical climate risks over a 30-year time horizon.

The initial results of the stress test show that climate change “represents a major source of systemic risk, particularly for banks with portfolios concentrated in certain economic sectors and, even more importantly, in specific geographical areas.” The most polluting companies, along with those in areas most vulnerable to physical risk, are exposed to up to four times as much climate risk as average firms over the next 30 years.

De Guindos concludes with the next steps for the economy-wide climate stress test. The results from the assessment of individual firms will be used to assess the resilience of 2,000 Eurozone banks to climate risks through loans, security and equity holdings. The ECB will also examine how changes in firms’ solvency translate into changes in bank-level vulnerability to climate risk. The full set of results is expected to be released by mid-2021.