Banks must take action on climate risk in face of extreme weather and low carbon transition — ECB

The European Central Bank has used its latest Risk Assessment to call on the region’s banks to “take adequate action” to manage climate exposure.

The document, which in undertaken by the ECB each year, identifies risks to European banks, partly based on conversations with the sector.

Of the 12 risks identified in the 2019 assessment – including cybercrime, geopolitical uncertainties and misconduct – climate change poses the lowest risk over the coming three years. This leads the authors to conclude that “climate-related risks do not pose a threat to the financial stability in the euro area in the short term”.

However, the ECB warns: “Banks can be impacted indirectly, but nonetheless materially, by more frequent and severe extreme weather events or by the ongoing transition to a low-carbon economy”.

“Weather phenomena could cause destruction in business sectors to which banks are exposed (e.g. agriculture) or destroy their collateral holdings. In addition, the transition to a low-carbon economy could impact certain economic sectors (e.g. fossil fuel companies, energy-intensive sectors, utilities, transport and building companies). Banks therefore need to take adequate action to manage their exposures to such sectors.”

Since 2013, the ECB has been in charge of supervising systemically important banks in Europe on top of its existing duty to secure financial stability.

There has been a growing push for the ECB to conduct an EU-wide climate stress test. The bank describes these kind of stress tests as “one of the primary supervisory tools” to ensure financial stability and identify potential risks, and it is mandated to work with the European Systemic Risk Board to coordinate relevant analysis.This means it could ask central banks to use a set of agreed methodologies, scenarios and assumptions to undertake parallel domestic stress tests, which would feed in to an EU-level assessment.

The Risk Assessment’s warning is the latest in a series of recent moves from central banks on the topic. Last month, the Bank of England stepped up its efforts by publishing draft guidelines on board oversight for climate, having unveiled the results of climate analysis for the banking sector in September.

“Weather could cause destruction in business sectors to which banks are exposed”

During the same period, the Netherlands’ DNB published the results of the first ever climate stress test conducted by a central bank, looking at four “severe but plausible” energy transition scenarios.

In a report published in recent weeks, outlining the current limitations of climate analysis, the Central Banks and Supervisors’ Network for Greening the Financial System encouraged the consideration of “forward-looking scenario analysis and stress tests” to help manage climate risk. The 18-strong body – including central banks in Germany, France, Australia and China – will turn its attention to providing “a small number of high-level scenarios” based on the recommendations of the TCFD.