The stress test prepared by the central bank warns that entities have “not sufficiently included” this contingency in their internal models
The latest stress test by the European Central Bank (ECB) shows how credit institutions in the eurozone have not yet sufficiently integrated climate risks into their internal models, despite some progress since 2020. Good conclusion from the body chaired by Christine Lagarde after subjecting 104 entities to this resistance test, although only 41 have completed it. With this data, the central bank estimates a negative impact of €70,000 million in light of unforeseen circumstances such as a rise in carbon prices, times of severe drought and complicated periods of flooding.
Because the companies and individuals who finance or insure the banks are also exposed to all these environmental hazards which, in a climate change environment, could affect their accounts if they eventually materialize. The ECB, which does not offer tests or results from financial groups in this case, but rather general ones, emphasizes that the entities have provided comprehensive and innovative information on climate risks, while at the same time regretting that most entities do not have sound frameworks for climate risk stress and lack relevant data.
“Euro area banks urgently need to step up their efforts to measure and manage climate risks, fill current data gaps and apply best practices already in place in the sector,” said Andrea Enria, chairman of the board of ECB supervision.
In total, 104 major banks participated in the test, which consists of three modules, although in the third the bottom-up stress test was limited to 41 directly supervised banks to ensure proportionality towards smaller banks.
In the first module of the assessment, banks provided information on their own climate stress testing capabilities, in the second they indicated their dependence on carbon-emitting sectors, and in the third, their performance in different scenarios was measured over time. assessed. horizons. “This exercise is a critical milestone in our journey to make our financial system more resilient to climate risk,” said Frank Elderson, vice chairman of the Oversight Board. “We expect banks to take bold action in the short to medium term and develop robust climate stress testing frameworks,” he added.
The results of the first module of the exam show that approximately 60% of banks still do not have a climate risk stress testing framework. Similarly, most banks do not include climate risk in their credit risk models, with only 20% considering climate risk as a variable when granting loans.
In this regard, the ECB warns that banks currently fall short of best practice, according to which they should set up climate stress testing capabilities that span different transmission channels for climate risks (e.g. market and credit risks) and portfolios (e.g. and mortgage).
In the second module of the test, the results indicate that a total of nearly two-thirds of bank revenues from non-financial corporate clients comes from greenhouse gas-intensive industries.
In many cases, the ECB notes, banks’ “funded issues” come from a small number of large counterparties, increasing their exposure to transition risks. Likewise, the institution recommends that banks intensify their commitment to the customer to obtain more accurate data and information about their transition plans, as it is a prerequisite for banks to measure and manage their exposure to climate risks in the future.
As for the stress test of the third module, which requires banks to project losses in extreme weather and transition scenarios with different time horizons, it confirms that physical risk has a heterogeneous impact on European banks.
In this way, the findings show that the vulnerability of banks to a drought and heat scenario depends to a large extent on the sectoral activities and the geographic location of their exposures, materializing its impact through a decline in sectoral productivity, as for example in agriculture and construction activities, and an increase in credit losses in the affected areas.
Likewise, in the flood risk scenario, real estate securities and underlying mortgages and corporate loans are expected to suffer, particularly in the worst affected locations.
The stress test shows that credit and market losses in a near-term disorderly transition and the two physical risk scenarios together amount to approximately €70 billion for the 41 banks in question.
In particular, about €53,000 million would correspond to losses recorded in the near-term disorderly transition scenario and another €17,000 million would correspond to losses recorded in short-term physical risk scenarios such as drought or flooding.
However, the ECB warns that “this significantly underestimates the real climate-related risk” as it only reflects a fraction of the real danger, due to the scarcity of data available at this early stage, the model underlying banks’ projections. that alone reflects rudimentary weather factors, excluding economic downturns and scenario spillovers, that the exposures examined represent only about a third of the total of the 41 banks.
Turning to banks’ long-term forecasts under various climate risk scenarios, the results show that an orderly green transition translates into lower losses than a disorderly or zero policy action.
However, the ECB emphasizes that banks hardly distinguish between different long-term scenarios, because they lack solid strategies, in addition to a tendency to reduce the exposure of the most polluting sectors and support companies with lower carbon emissions. Therefore, banks must consider direct and indirect transmission channels in their long-term strategic plans.
Source: La Verdad
I’m Wayne Wickman, a professional journalist and author for Today Times Live. My specialty is covering global news and current events, offering readers a unique perspective on the world’s most pressing issues. I’m passionate about storytelling and helping people stay informed on the goings-on of our planet.
