By Hans Bentzien
FRANKFURT (Dow Jones) — The European Central Bank (ECB) gained rather negative impressions in its first climate stress test for the big banks in the euro area. The majority of banks are unable to properly assess the impact of climate change and the risks associated with the transition to a lower-carbon economy on their balance sheets, according to the ECB’s report, which has just been released. It therefore attaches no particular importance to the result of the test, that banks would suffer short-term losses of only 70 billion euros in negative climate scenarios. According to ECB Director Frank Elderson, there is still no date for a new climate stress test. When presenting the report, however, he makes it clear that sooner or later the ECB will also take climate risks into account when measuring its risk-based capital requirements for banks.
The test was divided into three modules, which yielded the following results:
1. Only a third of banks “can do climate stress tests”
The results of the first module show that around 60 percent of banks do not yet have a climate risk assessment framework in place. In addition, most banks do not include climate risk in their credit risk models, and only 20 percent consider climate risk as a variable in lending. According to the ECB, banks currently do not meet the requirement that they should implement climate stress tests that take into account multiple transmission routes of climate risk – for example, via market and credit risks and portfolios (corporate and mortgage loans). “We appreciate banks’ efforts, but they need to address their weaknesses,” Elderson said. In the fourth quarter, the ECB wants to publish corresponding “best practices”.
2. Two-thirds of corporate loan income is climate gas intensive
The second module of the test shows that, overall, almost two-thirds of banks’ earnings from corporate loans come from greenhouse gas-intensive sectors. In many cases, the issues “funded” by banks come from a small number of large counterparties, increasing their transition risks. Banks often rely on estimates to gauge their exposure to high-emission sectors. “While this is a good first step in closing the data gaps, banks must try to get more accurate data from their customers,” the ECB urges.
3. Losses of 70 billion euros not the whole truth
The ECB had the banks calculate how high their short-term losses would be in a disorderly transition to a low-carbon economy and in two global warming scenarios. However, the ECB considers the result of 70 billion euros to be of secondary importance because it is based on various mitigating factors: there is a lack of data, the models used only partially take climate risks into account, neither economic downturns nor second-round effects are modeled, and fewer than half of the total banks involved participated in this element of the test.
“The focus is less on specific numbers and more on the qualitative insight that banks need to work on their capabilities,” Elderson said.
4. No date for the next climate stress test
When asked, the ECB Director said that the ECB has not yet set a date for the next climate stress test. In the short term, the results would have no impact on capital requirements, but they were qualitatively included in the ongoing supervisory process (Srep). At the same time, Elderson made it clear that one day climate risks will also have a direct impact on capital requirements. “Like all risks, climate risks will feed into our risk-based approach,” he said.
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(END) Dow Jones Newswires
July 08, 2022 04:50 ET (08:50 GMT)