Sobering Stress Test: European Banks Underestimate Climate Risk

Status: 07/08/2022 17:31

The largest financial institutions in the euro area do not yet have full control of the risks arising from climate change. This is shown by the first climate stress test conducted by responsible banking supervision.

Financial institutions in the euro area are still largely unaware of the dangers of climate change for them. This is criticized by Frank Elderson, a member of the Governing Council of the European Central Bank (ECB). He compares it to driving a car: “It is impossible to drive in the dark without lights,” says the deputy head of banking supervision at the ECB. “Banks need better data on climate risks.”

But that’s exactly what is missing. This is evidenced by the first climate stress test of 104 financial institutions in the currency area, including Deutsche Bank and Commerzbank. According to the ECB, most banks are not able to adequately calculate climate risk. So far they have relied heavily on estimates, says ECB director Elderson: “On the other hand, they should get more information from their clients to measure their risk positions appropriately.”

billionth risk of climate change?

The ECB’s supervisor urges banks to prioritize climate risks. According to Elderson, they rarely take them into account in their day-to-day activities, such as when making loans. Therefore, their customers are often companies that emit particularly large amounts of gas, such as carbon dioxide, which is harmful to the climate. According to the ECB, this alone is not a problem. As long as companies present plans to financial institutions on how they want to operate more sustainably in the future.

Otherwise, according to the central bank, there is a risk that banks will be surprised by political decisions aimed at greater stability of the economy. They are then threatened with losses, as well as as a result of natural disasters such as droughts and floods. In the worst case, the 41 largest financial institutions in the euro area alone could lose EUR 70 billion or more. Which institutes are involved remains open.

German bank representatives and supervisors relaxed

Overall, the German banking sector, which brings together all savings banks and bank associations, believes that the impact of climate change on the local banking landscape is financially manageable. “The published results show that the financial institutions involved do not have to expect any significant losses overall,” reads the written statement. Anyway, the whole thing is only an educational exercise, without any specific effects.

Germany’s highest banking supervisor, Joachim Wuermeling, a member of the Bundesbank board of directors, is also pleased. He says 21 local institutes did well in the climate stress test: “They have developed an awareness that new threats are appearing on their risk map, and that is good.” They are not more affected by these climate threats than other European banks. Nevertheless, Wuermeling sees room for improvement in one area or the other and expects financial institutions to close data gaps and take greater account of climate risk in their risk management.

Not all climatic hazards can be registered

Banks can’t predict everything anyway, warns Karolin Kirschenmann, banking expert at the Leibniz Center for European Economic Research in Mannheim. “Assuming the price of CO2 rises sharply because the government believes the 1.5 degree climate target cannot otherwise be met, it could lead to a recession and hit all banks,” says the economist. Assessing such risks is difficult. For this reason, Kirschenmann believes that the relevance of the climatic stress test is limited.

With a view to the public debate on climate change, he warns that the role of financial institutions should not be overestimated. Obviously, in connection with the stress test, they would have to deal more with climate change and its financial consequences. And by channeling cash flows in a targeted manner, financial institutions can help them transform the economy towards more sustainable development. “But it must go hand in hand with an ambitious climate and economic policy,” said a banking expert.

The stress test for ECB banking

Ursula Mayer, HR, 8/7/2022 17:26

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