Europe’s banks aren’t sufficiently considering risks from climate change and must “urgently step up efforts” to make sure they understand the possible impact of floods, wildfires, and losses on investments, The European Central Bank concluded Friday, based on a stress test it conducted on 104 banks.
The bank’s supervisory arm warned that as things stand now, 60% of the 104 surveyed banks have no framework for assessing the impact of climate risk on their financial solidity, and only 20% consider climate risk when granting loans, The Associated Press reports.
Banks in southern Europe were more exposed to risks from heat and drought that could hit construction and agricultural businesses, the report indicated.
For now, the climate stress test was a learning exercise that will not result in any requirements for banks to strengthen their financial buffers against possible losses, the ECB said.
But it warned that banks “currently fall short of best practice” in assessing the risk that borrowers will not be able to repay loans due to climate-related incidents. It noted that almost two-thirds of bank income comes from corporations in industries that emit large amounts of carbon dioxide, leaving them vulnerable to losses as businesses are forced to shift to lower-emission production.
Banks have received feedback from the ECB and “are expected to take action accordingly” under the supervisor’s best practices guidelines. The ECB is the banking supervisor for the 19 countries that use the Euro, and AP explains that banks are key to keeping the European economy running well because they’re the primary source of credit and financing for businesses—in contrast to the United States, where more financing comes from financial markets.
The report said a smaller sample of 41 banks from the test would have suffered €70 billion in losses under a “disorderly transition” scenario in which the price of carbon emissions rose dramatically over a three-year period.
The report said banks will suffer lower losses if efforts to fight climate change are stepped up enough to keep the increase in global average temperatures to 1.5°C or less. Losses are larger in scenarios in which efforts to limit climate change are postponed and then drastically increased, or simply not undertaken.
But banks “barely differentiate” between differing long-term scenarios that could affect their businesses, the ECB said.
The bank said the findings from the test should serve as “a compass” for banks to boost their awareness of climate issues and prepare for the risks and opportunities of a transition to net-zero emissions.
This Associated Press story was republished by The Canadian Press on July 8, 2022.