Environmental protesters take to the streets during a Fridays for Future demonstration in the financial district of Frankfurt, Germany, in August last year.
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The results of the European Central Bank’s first climate risk stress test show that most eurozone banks do not sufficiently incorporate climate risk into their internal stress testing frameworks and internal models.
In a report released on Friday, the ECB said the findings reaffirm the view that banks should focus on climate risk.
It comes at a time of intense heat and low rainfall in southern Europe, rising energy prices and the prospect of stopping the region’s gas supply from Russia in retaliation against sanctions imposed by the Kremlin attack on Ukraine.
Undoubtedly, the world’s leading climate scientists have warned that humanity has arrived in the territory “now or never” to avoid the worst of what the climate crisis has in store.
“Euro area banks urgently need to intensify efforts to measure and manage climate risk, closing current data gaps and adopting good practices that are already present in the sector,” said Andrea Enria, president of the ECB supervisory board, in a statement.
A total of 104 banks took part in the test, which is the first of its kind, the ECB said, providing information on three modules or categories. These included their own climate stress testing capabilities; its dependence on carbon-producing sectors; and their performance in different scenarios on various time horizons.
The results of the first module found that approximately 60% of banks do not yet have a climate risk stress testing framework.
Similarly, the ECB said that most banks do not include climate risk in their credit risk models and only 20% consider climate risk as a variable when granting loans.
With regard to banks ‘dependence on carbon-producing sectors, the ECB said that, on the whole, almost two-thirds of banks’ revenues from non-financial corporate clients come from greenhouse gas-intensive industries.
In many cases, the report found that banks’ “funded issues” come from a small number of large counterparties, which increases their exposure to emissions-intensive sectors.
Within the third module, the results were limited to 41 directly supervised banks to ensure proportionality with the smaller banks. It required lenders to project losses on extreme weather events in different transition scenarios.
The results warned that credit and market losses could amount to about 70 billion euros ($ 70.6 billion) in total this year for the 41 directly supervised banks.
The ECB noted, however, that this “significantly underestimates the real climate-related risk” as it only reflects part of the real danger. This is due, in part, to the scarcity of available data.
“This exercise is a crucial milestone in our path to making our financial system more resilient to climate risk,” said Frank Elderson, vice-chairman of the ECB’s supervisory board. “We expect banks to take decisive action and develop solid frameworks for climate stress testing in the short to medium term.”
ECB President Christine Lagarde said earlier that the central bank was taking steps to incorporate climate change “into our monetary policy operations”.
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The ECB said it collected both qualitative and quantitative information, with the aim of assessing the sector’s preparedness for climate risk and gathering best practices for tackling climate-related risk.
The report concluded that most banks should work harder to improve the governance structure, data availability, and modeling techniques of their stress testing frameworks.