The ECB’s climate risk stress test: banks systematically underestimate risk

European Central Bank presents results of climate risk stress test

(Sustainabilityenvironment.com) – With a further surge in energy prices and the burden on the economy due to drought or extreme heat, European banks have 70 billion assets at risk. A very conservative estimate: the losses are certainly underestimated and do not take into account all the possible indirect impacts of similar events on the banking sector. This is said by the European Central Bank (ECB) presenting the results of the climate risk stress test on a sample of 104 credit institutions in Europe.

The most challenging part of the climate stress test asked credit institutions to consider climate change risk assessments in particularly adverse but plausible scenarios. In particular, simulate the composite impact on the portfolio of extreme climate events and a disordered energy transition, for example with energy price shocks. Hence the end result of 70 billion assets at risk.

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A figure much lower than the real one, to which we arrive, emphasizes the ECB, because the simulation models used by banks are “rudimentary” and the impact of the overall slowdowns in the economy and the negative cascading effects that would result from the expected climate shocks in the different scenarios are not taken into account.

There is also a problem with making valid long-term assessments. The results show that an orderly green transition results in lower losses than a disordered transition or the absence of political action. However, the ECB notes, “banks cannot distinguish between different long-term scenarios because they do not have sound strategies, other than the tendency to reduce the exposures of the most polluting sectors and to support companies that emit less carbon”.