Home Credit report ECB stress test shows most banks are not including climate risk in credit models

ECB stress test shows most banks are not including climate risk in credit models


Environmental protesters took to the streets during a Fridays for Future protest in the financial district of Frankfurt, Germany last August.

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The results of the European Central Bank’s first climate risk stress test show that most banks in the euro area do not sufficiently integrate climate risk into their stress test frameworks and internal models.

In a report on Friday, the ECB said the findings reaffirm the view that banks need to focus more on climate risk.

It comes at a time of high heat and low rainfall in southern Europe, rising energy prices and the prospect of a retaliatory shutdown of gas supplies to the region from Russia. the sanctions imposed following the attack on the Kremlin in Ukraine.

Certainly, the world’s leading climate scientists have warned that humanity has reached “now or never” territory to avoid the worst of what the climate crisis has in store.

“Banks in the euro zone must urgently step up their efforts to measure and manage climate risk, close current data gaps and adopt good practices already present in the sector,” said Andrea Enria, chairman of the board. Supervisory Board of the ECB, in a press release.

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; their dependence on carbon-emitting sectors; and their performance under different scenarios over multiple time horizons.

The results of the first module revealed that around 60% of banks do not yet have a climate risk stress testing framework.

Similarly, the ECB said most banks do not include climate risk in their credit risk models and only 20% consider climate risk as a variable when making loans.

As for banks’ reliance on carbon-emitting sectors, the ECB said that globally almost two-thirds of banks’ revenues from non-financial corporate clients came from greenhouse gas-intensive industries. tight.

In many cases, the report found that banks’ “funded emissions” come from a small number of large counterparties, increasing their exposure to emissions-intensive sectors.

In the third module, the results were limited to 41 directly supervised banks to ensure proportionality towards small banks. It required lenders to project losses during extreme weather events under different transition scenarios.

The results warned that credit and market losses could amount to around 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” because it reflects only a fraction of the real danger. This was due, in part, to the paucity of available data.

“This exercise is a crucial step on our way 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 robust climate stress testing frameworks in the short to medium term.”

ECB President Christine Lagarde has previously said the central bank is taking steps to integrate climate change “into our monetary policy operations”.

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The ECB said it collected qualitative and quantitative information, with a view to assessing the sector’s preparedness for climate risks and gathering best practices for addressing climate-related risks.

The report concluded that most banks should work more on improving the governance structure of their stress testing frameworks, data availability and modeling techniques.