Yesterday, the European Central Bank published the first stress test focused on analyzing the climatic risks faced by banks, with an expected conclusion. “Banks still do not take climate risk sufficiently into account in their stress testing frameworks and internal models, although they have made some progress since 2020.”
The truth is that only 49 of the 104 entities, 47% that were subject to the study, have passed the demanding analysis process imposed by the regulator. For them, an approximate risk of 70,000 million euros has been detected. “It is urgent that credit institutions in the euro area intensify their efforts to measure and manage climate risk by eliminating current data gaps and adopting good practices that are already applied in the sector,” said Andrea Enria, President of the Council. of ECB Supervision.
The consequences of this failure will not go beyond this advice. There will not be, as is usual with the stress tests carried out on European banks since the 2008 crisis, capital penalties or any other type. Not even public information on the results obtained by each entity. Because, as the ECB itself recalls, this has been a “learning” exercise for everyone.
The objective is for the sector to learn to include in its risk prediction models the impact of the inclemency of climate change, such as major droughts, floods, heat or cold waves, as was the case with snowfall Filomena.
Of course, it is not easy. According to financial sources, there is not even a unified model to quantify these impacts, which are very different according to the sectors, the geographical areas in which the entities have exposure, etc. It has been this complexity that has prevented the vast majority from completing the test. “This exercise is a fundamental milestone in our journey to achieve a financial system that is more resilient to climate risk. We expect banks to take decisive action and build robust short- to medium-term climate stress testing frameworks,” said Frank Elderson, Vice Chairman of the Supervisory Board. The ECB has analyzed, on the one hand, the capacity of each entity to carry out this type of test. Whether or not you have enough tools, people, data…
The result is that 60% of entities do not yet have a stress testing framework on climate risk. Most do not even include this concept in their credit risk models, and only 20% take it into account as a variable when granting loans.
Secondly, the stress test has analyzed the dependence of the accounts of each entity on clients belonging to sectors that are intensive in carbon emissions. At this point, the ECB recommends greater interaction with clients to specify risks. For example, a client in the energy sector does not have the same risk if his activity is in the coal market as in the windmill market. While entities with a presence in Spain are more exposed to drought and Central European entities to floods.
Finally, the ECB asked the 41 entities it directly supervises to make projections of losses in the face of extreme weather events and in transition scenarios with different time horizons. An extreme drought and heat wave in which productivity drops are generated in the most exposed sectors such as agriculture or construction, in addition to productivity losses. In the second case, the floods reflect the deterioration of mortgage guarantees and loan defaults.
The aforementioned 70,000 million losses would occur in the framework of a disorderly and short-term green transition. Although the ECB itself warns that this “amount considerably underestimates the real climate risk” due to the limited availability of data and the fact that the models reflect the climate impact in a “rudimentary” way. For this reason, it does not give a specific figure for the long-term impact, although it does recognize that an orderly long-term green transition would generate fewer losses than a disorderly one in the short term and even than the option of doing nothing about climate change.
