ECB’s First Climate Test Sees Up to $71 Billion Hit to Banks

The European Central Bank’s first major climate stress test shows banks facing a hit of 70 billion euros ($71 billion) if the transition to a lower-carbon economy is disorderly.

The figure includes credit and market losses, while droughts, heat and floods alone could mean a hit of 17 billion euros, the ECB said on Friday in Frankfurt. It cautioned that the result “significantly understates” actual risks related to global warming, partly because climate shocks weren’t accompanied by a broader economic downturns and limited to specific portfolios.

The ECB also found that 60% of banks don’t yet have a climate risk stress-testing framework. Most lenders don’t include climate risk in their credit-risk models, and just one in five consider it as a variable 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,” said Andrea Enria, chairman of the ECB’s Supervisory Board.

A total of 104 banks participated in the test that has been presented as a learning exercise for banks and regulators alike. Yet the impact was far softer than many banks had expected and the industry is already using the results to lobby against efforts by some ECB officials keen for lenders to set aside more money to cover climate risks.

Bloomberg reported earlier this week that the toughest hypothetical scenarios in the test didn’t result in losses that would make a meaningful dent in capital buffers at banks.

The ECB said while the results of the stress test will feed into its annual review of risks banks face, there won’t be any direct impact on capital through the Pillar 2 guidance this year.

That might change in the future, according to Frank Elderson, the Executive Board member who serves as vice chair on the ECB’s Supervisory Board.

“It’s clear that climate-related risks are among our top priorities,” he told reporters during a press conference. “As with many new, emerging risks, it takes time to properly address them and we understand that. But it’s also true that as all material risks, climate-related factors will eventually be integrated in our risk-based supervisory approach.”

The ECB found that almost two-thirds of banks’ interest income from non-financial corporate customers stems from greenhouse gas-intensive industries, with higher-emitting sectors account for 21%.

It also criticized that banks “barely differentiate” between various long-term scenarios on climate change, saying they’re lacking “robust strategies” beyond reducing exposures to the most polluting sectors and supporting lower-carbon emitting businesses.

“While this is a good first step to closing the data gaps, banks need to step up their customer engagement to obtain more accurate data and insights into their clients’ transition plans,” the ECB said in a statement. “This is a precondition for banks to gauge and manage their exposure to climate risks going forward.”