ECB confirms work on climate stress test framework despite ‘major barriers’

Speech by ECB Vice President Luis de Guindos.

The European Central Bank (ECB) is developing an analytical framework which will allow it to test for climate-related transition risks in the euro area banking sector, ECB Vice President Luis de Guindos has confirmed.

Speaking at the European Savings and Retail Banking Group Conference, de Guindos said: “We are currently developing an analytical framework for carrying out a climate risk stress test analysis for the euro area banking sector. The pilot test framework will be macroprudential in nature, and allow us to analyse the system-wide materiality of transition risks for banks’ solvency, along with their lending capacity and the implications for the overall economy. 

“The eventual aim is to incorporate both physical and transitional risks and investigate how these two types of risks interact with each other.”

Transition risks arise from the process of adjustment towards a lower-carbon economy such as new policies penalising climate laggards or product obsolescence due to the rise of new technologies, while physical risk refers to the effects of exposure to the changing climate.

In his speech, former Spanish economy minister de Guindos described the challenges faced by the ECB in developing such a framework. 

He said: “This type of analysis still faces some major barriers. There is no consistent classification of firms’ activities and the data on banks’ exposures is not granular enough.”

Over the past two years, the EU has drafted a common catalogue of activities which are to be considered green under the EU Sustainable Action Plan, also known as the green taxonomy. Currently the taxonomy is the focus of political negotiations between the EU’s three institutions, in a process known as trilogue, and may only enter into force by end-2022.

According to an ECB spokesperson, the climate stress test is intended as a permanent component of the bank’s financial stability review, which takes place twice yearly.

The regime is jointly coordinated by the European Banking Authority (EBA), which carries out EU-wide assessments of banks, and the ECB, which focuses on the euro area. The tests are micro prudential in nature and aim to measure general resilience to adverse financial and economic circumstances.

In the years which the EBA does not conduct a stress test, the ECB conducts a narrowly defined ‘sensitivity analysis’ among regulated banks relating to a theme of its choice. In recent years, it has looked at liquidity risk (2019) and the impacts of low interest rates (2017).

The confirmation from the ECB comes only a week after de Guindos was quoted saying that the ECB was “considering” stress-testing for climate risk.

The concept of assessing organisational resilience in different climate scenarios has gained traction among corporates and investors since it was included in the final recommendations of the Taskforce for Climate-related Financial Disclosures (TCFD).