Eurozone banks are underestimating the hit from climate change, warns ECB

Eurozone banks are poorly equipped to measure the risks of global warming on their loan books and underestimate the losses they are likely to suffer, the European Central Bank’s debut climate stress test has found.

The ECB said a figure of €70bn of losses from the short-term impact of higher carbon emission prices and extreme weather events, put together by 41 of the biggest banks in the currency bloc, “significantly understates the actual climate-related risk”.

The central bank said many of those involved in the test lacked data, had insufficient internal models, and the exercise only covered a third of their total balance sheet exposures.

The ECB refused to provide any detail on the 41 banks that produced the €70bn estimate. But the figure is dwarfed by the €25tn of assets and €1.6tn of equity that all the 113 banks supervised by the central bank had at the end of last year.

Frank Elderson, vice-chair of the ECB supervisory board, told reporters that banks needed to work on their capabilities to calculate the risks. “This was a learning exercise,” he said.

The ECB is the latest major central bank to assess the risks of global warming for banks, following similar exercises at the Bank of England and the People’s Bank of China over the past year. The BoE said in May that UK banks and insurers that fail to manage the risks associated with climate change could suffer a 10 to 15 per cent hit to their annual profits, with lenders’ credit losses soaring as high as £225bn by 2050.

The ECB said only a fifth of all 104 banks it assessed took account of climate change in their credit risk models, two-thirds did not have “robust climate risk stress-testing frameworks” and most “lack relevant data”. Two-thirds of the 104 banks scored poorly in their capabilities for assessing the risk of global warming.

Almost two-thirds of banks’ income from corporate customers came from greenhouse gas-intensive industries, the ECB said. In many cases exposures were concentrated in a small number of companies.

The Association for Financial Markets in Europe, a bank lobby group, acknowledged there was “much more to do” but said its members were “defining data collection templates” to close gaps in the data they have on climate risks at corporate clients.

Campaigners criticised the central bank for not being tough enough.

Some flagged that the stress tests did not take into account the higher cost of energy triggered by the war in Ukraine. “It all seems a bit anachronistic as the energy shock they are simulating is happening already,” said Stan Jourdan, head of pressure group Positive Money Europe.

Mauricio Vargas, finance expert at Greenpeace, blasted the exercise as “a toothless tiger” and said it was “frightening” the degree to which banks continued to underestimate the impact of climate change.

Elderson acknowledged the results would have no direct impact on the amount of capital banks need. But he said supervisors could call for banks to set more capital aside, under what is known as pillar 2 guidance.

Elderson said the ECB would also consider changing the rules for future climate stress tests, including potentially adding a severe economic downturn.

Even the worst-case scenario under the longer-term 30-year test included in the stress test produced losses amounting to less than 0.2 per cent of banks’ loan books. Elderson said this was partly because banks could assume they ditched exposure to clients hit hardest by climate change — unlike the BoE’s test, which forced lenders to calculate losses based on the composition of their current balance sheet.