ECB Report Highlights Banks’ Exposure to Climate-Related Risks

This commentary analyses the report ‘Climate-related risk and financial stability’ published by the European Central Bank in July 2021. We look at the results of the ECB analysis including the challenges encountered in data collection as well as the transmission of climate-related risk drivers into financial risks for banks.

Summary highlights of the report include:

• More than 70% of the banks’ credit risk exposures to firms in areas of high or increasing physical risk are concentrated in just 25 EU banks. However, these banks are generally large and well-diversified and, as a result, the credit exposure outlined above does not exceed 7% of the banks’ total assets

• The 25% of most weakly capitalised and/or less profitable banks are on average more exposed to firms in areas of high or increasing physical risk. As such, climate risk might exacerbate existing vulnerabilities for these banks.

• The banks’ exposure towards climate policy relevant sectors represents a limited 14% of the banks’ total balance sheet. As such, the overall exposure to transition risk appears manageable albeit concentrated in specific sectors which presents a certain degree of vulnerabilities.

“We view positively that European banks are starting to incorporate climate change risks into their risk management and stress testing frameworks, and some banks are also incorporating ESG risk factors into the credit risk assessment of their corporate loan portfolio. We also expect banks to increasingly focus on supporting the transition to a low-carbon economy of their customers which in turn have a long-time horizon (10-30 years) ahead in order to meet the principles of the Paris agreement. However, banks that are struggling financially are less well positioned to factor in climate related risk issues in their risk management approach” said Mario De Cicco from DBRS Morningstar’ Global Financial Institutions team.