The ECB's first climate stress test has highlighted that the regulator and eurozone banks must close data gaps if they want to accurately assess and address the impact of climate change.
The central bank released the results of its climate stress test last Friday, finding that eurozone banks are woefully underprepared for the impact of climate change.
Like eurozone government bond spreads, measuring the impact of climate change is fragmented across the bloc, with the availability of data a key sticking point.
Just over a fifth of banks that do not have a climate stress testing framework said that accessing suitable data proved challenging. Even then, those with frameworks in place still struggle, with many saying that their corporate clients do not disclose the required data.
As a result, this first stress test is flawed. In an assessment of 41 directly supervised banks, the ECB found that a short-term worst-case scenario would result in a combined €70bn credit and market loss.
Averaging out at just over €1.7bn per bank, this would register as a blip on bank balance sheets, with banks chalking up larger losses in the past without blowing through all their capital. And even then, this part of the stress test only considers about a third of the bank’s total exposures.
Furthermore, this time round the ECB did not include the impact of a climate related economic downturn in its stress tests despite huge effect climate change could have on the global economy.
According to climate stress test analysis run by Swiss Re last year, the global economy could shed up 18% of its GDP by 2050 if nothing is done to combat climate change, with Europe’s losses standing at 11%.
But even now, climate change is already costing the economy. For instance, Munich RE estimates that last summer’s flooding in Central Europe caused over €46bn of losses, making it the costliest flood all time.
Meanwhile this week’s heatwave in Europe will no doubt have a high cost in terms of lost productivity, with temperatures in Paris, Frankfurt and London set to reach the high 30s over the next week.
And these freak weather events are set to become even more frequent. For instance, annual flood damages in Europe could grow sixfold by 2100 if the average global temperature rises by 3°C, according to the EU’s PESETA IV climate change study.
As temperatures rise, the UK’s Met Office decided to redefine what constitutes a heatwave earlier this year, raising the minimum temperature requirement and in turn normalising higher temperatures. Europe’s last seven years were the hottest on record, according to the EU’s Copernicus Climate Change Service, with 2022 likely to join them.
And as these events increase in frequency and extremity, so too will the pressure on governmental bodies and banks to act. Despite the myriad of net zero pledges, banks still rely on greenhouse gas intensive industries, with almost two thirds of their corporate income coming from these sectors, according to the ECB.
However, in highlighting and admitting deficiencies the ECB and its assessed banks have taken a first positive step. But both must still take the results of this debut stress test on board, and with the window to address climate change shrinking, they must do so fast.