Fossil fuel: the new sub-primes? How funding the climate crisis can lead to a financial crisis

This assessment of the climate-related financial risks facing the 11 largest banks in the eurozone finds that they are highly exposed to a collapse in fossil fuel asset values, with potential contagion effects threatening financial stability. Comparing fossil fuel assets to the US sub-prime mortgages that touched off the 2008 financial crisis, the report offers policy proposals to address this risk first by preventing new investment in the fossil fuel sector and then by decarbonising bank balance sheets.

Jointly published by Reclaim Finance, Friends of the Earth France and the Rousseau Institute, the analysis finds that the banks examined have accumulated €532 billion in fossil fuel assets, representing 95% of their total equity. In the hypothesis of an 80% loss in asset values, Crédit Agricole5 and Société Générale — the 3rd and 4th largest banks studied — could be in the red and the reserves of Deutsche Bank and Commerzbank would nearly be exhausted, the report shows, warning of the potential impacts on financial stability.

“These fossil assets represent only the tip of a gigantic iceberg representing all sectors requiring a transition — aeronautics, automotive, petrochemicals, etc.,” the authors say, “Therefore, we cannot rule out a snowball effect, triggering a major crisis.”

In addressing this systemic risk the most urgent policy response is to end new investment in the fossil fuel sector, the report finds. This can be done by excluding fossil assets from the ECB’s asset purchases and collateral framework and by aligning all of its operations with the Paris Agreement. Financial regulations should fully account for the risks associated with funding fossil fuels, the authors propose, with increased capital requirements, the creation or adjustment of systemic risk buffers, the strengthening of bank deposit guarantee rules and the introduction of frameworks regulating the securitisation of fossil assets.

To decarbonise bank balance sheets in a gradual and orderly way, the report suggests that the ECB create a European “fossil bank”, financed by the ECB’s asset purchases. This fossil fuel version of a ‘bad bank’ would buy back fossil assets from banks exiting fossil fuels, and manage their gradual phase-out. The report outlines conditions to ensure that banks do not avoid all responsibility, including the application of a discount on the value of assets purchased.

“Ending our addiction to fossil fuels will eventually lead financial assets tied to fossil fuels to lose all market value,” the report concludes, warning that the climate-related transition risk associated with the speed of phasing out of fossil assets is a real and immediate challenge.

Data used in compiling the report was taken from banks’ official documents and consolidated balance sheets and the share of fossil assets in credit and investment assets was determined from allocation keys built using sectorial, economic and financial data. The full data set employed is available here.

Endorsed by 12 civil society organizations, the report has received wide media coverage and is accompanied by a comprehensive FAQ.