The European Central Bank (ECB) has published the results of an inaugural climate stress test conducted on its own balance sheet and those of the 20 EU central banks that use the euro.
These exercises have become a permanent fixture in the ECB’s annual supervisory calendar since it conducted the first economy-wide stress test in 2021, followed by last year’s exercise which covered 104 major EU banks, but this is the first time that the bank has put itself to the test.
In its most recent exercise, the ECB found that the Eurosystem’s corporate bond holdings have a similar degree of climate risk compared to the outstanding market for bonds that meet the central banks’ eligibility criteria for purchases.
The ECB began introducing a so-called “green tilt” to bond purchases in October – which fell beyond the cut-off date for the stress test in June – and so “this outcome was expected”, said the supervisor.
Other Eurosystem assets, namely covered bonds and asset-backed securities (ABS), which often employ real estate as collateral or to generate cash, showed an elevated vulnerability under scenarios where no climate policies are introduced resulting in a failed transition, or a Europe-wide flood.
The methodology used in the exercise is in line with the previous two climate stress tests conducted by the ECB and is the second vintage to be produced by global green central banking collective the Network for Greening the Financial System (NGFS). The strength of climate policies is represented by a hypothetical price on carbon over a 30-year period.
ECB staff included two additional short-term scenarios: a flood risk scenario, and a disorderly scenario that incorporates sharp increases in carbon prices.
The completion of the exercise delivers on a key plank of the ECB’s 2021 strategy to integrate climate change into its supervisory activities. The ECB has already made climate a factor in its bond purchases, collateral framework, bank regulatory capital and portfolio disclosures.
Eurosystem climate-related disclosures
In related news, the central banks of Germany, Portugal, Estonia, Ireland, Greece, Cyprus, Portugal, Finland, Latvia, Malta, the Netherlands, Slovenia, Spain and Slovakia have published TCFD-aligned reports of their investment portfolios – many for the first time.
In 2021, the ECB and all 19 central banks that made up the Eurosystem at the time – Croatia joined a year later – adopted a “common stance” to report on the climate performance of their investments by 2023.
The disclosure quality and performance reported by the banks are highly dependent on data availability and portfolio composition. For example, the Banco de Portugal reported a 76 percent data coverage for non-sovereign issuers, while Latvia’s Latvijas Banka reported 30 percent coverage.
The degree of data coverage reported by central banks also varied from year to year making it difficult to assess changes in overal carbon intensity. The disclosures cover Scope 1 and 2 emissions.
Separately, Denmark’s central bank, which is not part of the Eurosystem, reported a more than 50 percent reduction in the carbon intensity of equity and corporate bond holdings after switching to the EU’s climate benchmarks.