ECB climate stress test flags $71 billion risk to euro zone banks

A sudden jump in carbon prices coupled with floods and droughts this year would lead to losses of at least 70 billion euros ($71.1 billion) for the euro zone’s largest banks, the European Central Bank said on Friday.

The ECB said the estimate in its first climate stress test significantly understated actual losses for the 41 banks in the sample as it only focussed on credit and market risk and did not factor in indirect effects such as an economic downturn.

Banks and other companies are under increasing pressure from their shareholders and environmental group to act quickly to reduce the carbon footprint of their activities.

The central bank’s test also found that most euro zone banks did not have a framework for modelling climate risk and did not typically take it into account when granting loans.

“Euro area banks must urgently step up efforts to measure and manage climate risk, closing the current data gaps and adopting good practices that are already present in the sector,” the ECB’s chief supervisor Andrea Enria said.

The ECB said the findings will not have an impact on the amount of capital banks will need to have and will only feed into its supervisory work “from a qualitative point of view”.

The ECB is carrying out a separate “thematic review” to gauge banks’ progress towards incorporating climate and environmental risk into their business. It expects them to meet its expectations by the end of 2024 at the latest.

The Bank of France was first among central banks to undertake a climate stress test of banks and insurers last year, followed by the Bank of England.

In its exercise, the Bank of England found that banks and insurers that fail to manage climate risks as a “first-order” issue could face a 10% to 15% hit to annual profits and higher capital requirements.

($1 = 0.9845 euros)