Bloomberg | Bloomberg | Getty Images The results of the European Central Bank’s first stress test show that most euro area banks do not sufficiently integrate climate risk into their stress testing frameworks and internal models. In a report published on Friday, the ECB said the findings confirm the view that banks should focus their attention on climate risk. It comes at a time of intense heat and rare rainfall in southern Europe, rising energy prices and the prospect of Russia cutting off gas supplies to the region in retaliation for sanctions imposed over the Kremlin’s attack on Ukraine. Certainly, the world’s leading climate scientists have warned that humanity has reached “now or never” ground to avert the worst of what the climate crisis has in store. “Eurozone banks urgently need to step up their efforts to measure and manage climate risk, closing current data gaps and adopting good practices that already exist in the industry,” said Andrea Enria, president of the ECB’s supervisory board. A total of 104 banks participated in the test, which is the first of its kind, the ECB said, providing information on three sections or categories. These included their own climate stress testing capabilities. their dependence on carbon-emitting sectors; and their performance under different scenarios over several time horizons. The results of the first section found that around 60% of banks do not yet have a climate risk stress control framework in place. Similarly, the ECB said most banks do not include climate risk in their credit risk models and just 20% consider climate risk as a variable when they make loans. Regarding banks’ reliance on carbon-emitting sectors, the ECB said that overall, almost two-thirds of banks’ income from non-financial corporate clients comes from greenhouse gas-intensive industries. In many cases, the report found, banks’ “financed emissions” come from a small number of large counterparties, increasing their exposure to emissions-intensive sectors. In the third section, the results were limited to 41 directly supervised banks to ensure proportionality to smaller banks. It required lenders to forecast extreme weather losses under different transition scenarios. The results warned that credit and market losses could total around 70 billion euros ($70.6 billion) this year for the 41 directly supervised banks. The ECB noted, however, that this “significantly underestimates the actual climate-related risk” as it reflects only a fraction of the actual risk. This was due, in part, to a lack of available data. “This exercise is a critical milestone 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 strong climate control frameworks in the short and medium term.” ECB President Christine Lagarde previously said the central bank was taking steps to integrate climate change “into our monetary policy operations”. Bloomberg | Bloomberg | Getty Images The ECB said it collected both qualitative and quantitative information, with the aim of assessing the industry’s climate risk preparedness and collecting best practices for addressing climate-related risk. The report concluded that most banks should work further to improve their governance structure, data availability and stress modeling techniques.
