In a report published today, the European Central Bank estimates that banks could potentially lose 70 billion euro over the next three years due to climate-related risk. Finance Watch warns the stress test undertaken by the ECB has many limitations that call into question the usefulness of this estimate, especially the finding that banks are not able to accurately account for climate risk using their existing credit risk models. What’s more, the conclusion that there will be “no direct capital implications” simply means that this remains an exploratory exercise rather than a true stress test.
Finance Watch calls on the ECB to issue a clearer warning against taking the results of this stress test at face value. More emphasis must be placed on the fact that this was “essentially a learning exercise” with a very constrained scope. A lack of clarity could play into the hands of those who oppose decisive action to address climate risks.
70 billion euro is the only loss number included in the report. It covers only 41 out of 104 significant banks and accounts for only one-third of their total exposures (the report does not give the share of Eurosystem banking assets which were captured by the exercise). Only losses from the three-year scenario are included. This time horizon is at odds with that of climate-change. The ECB remained silent on the estimated effects of its 30-year transition scenarios.
The most severe climate stress test scenario in the report does not include any economic downturn accompanying the negative climate effects. The world GDP features grows by 57% in 2050 compared to 2021 even in the hot house world scenario. This compares strikingly to the projections of -18% global GDP impact in the analyses done by Swiss Re.
Policymakers increasingly look for climate stress test results to drive policy implications. The signalling power of stress tests is particularly important now in the European Union, where banking prudential rules are currently under review and Members of the European Parliament are due to submit their proposals to amend the prudential rules in Capital Requirements Regulation and Directive (CRR/CRD) next week.
Julia Symon, Head of Research & Advocacy at Finance Watch said:
“Today, there are many “known unknowns”, but there are even more “unknown unknowns” when it comes to climate risk. Regulators should pay attention to the alarming insights in the ECB report, such as the fact that global systemically important banks hold the largest share of exposures to the most carbon-intensive industries. Risk concentration in the largest systemically important banks means we could end up back at the too-big-to-fail scenario once climate risks start materialising.
At the same time, I strongly caution policymakers against taking the results of this stress test at face value, especially those in the EU who are currently designing prudential measures to address climate-related risks. Work is ongoing to improve the climate stress test, but right now, it’s still very much a “learning exercise”.”
About Finance Watch
Finance Watch is an independently funded public interest association dedicated to making finance work for the good of society. Its mission is to strengthen the voice of society in the reform of financial regulation by conducting advocacy and presenting public interest arguments to lawmakers and the public. Finance Watch’s members include consumer groups, housing associations, trade unions, NGOs, financial experts, academics and other civil society groups that collectively represent a large number of European citizens. Finance Watch’s founding principles state that finance is essential for society in bringing capital to productive use in a transparent and sustainable manner, but that the legitimate pursuit of private interests by the financial industry should not be conducted to the detriment of society.
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