The European Central Bank (ECB) has published the results of its recent climate stress test, which looked at the impact of climate change on more than four million firms and 1,600 euro area banks under three different climate policy scenarios.
The results suggest that firms and banks can benefit from adopting green policies early on in order to foster the transition to a zero-carbon economy, and these businesses could be severely affected under a scenario where no action is taken.
Luis de Guindos, Vice-President of the ECB, commented: “It is essential to transition early on and gradually, so that we can mitigate the cost of both the green transition and the future impact of natural disasters.”
The ‘economy-wide’ test marks the first step in the ECB’s climate roadmap, and shows that the advantages of taking earlier action outweighs the initial costs over the medium to longer term.
“Without policies to transition to a greener economy, physical risks will increase over time. They will increase non-linearly, and due to the irreversible nature of climate change, this increase will continue over time,” added Guindos.
The test revealed that the impact of climate risk is concentrated in certain regions and sectors of the euro area. Particularly, firms located in regions most exposed to physical risk could face very severe and frequent natural disasters, which would in turn affect their creditworthiness.
The expected losses on corporate loan portfolios are shown to rise significantly over time, driven by ever increasing physical risk, with the potential of becoming ‘critical’ over the next 30 years.
The company shared that in 2050, the average corporate loan portfolio of a euro area bank will be 8% more likely to default under the hot house world scenario than under an orderly transition.
Businesses most vulnerable to climate risk are 30% more likely to default in 2050 compared with 2020 under the hot house world scenario: this increase is five times larger than the average increase under the same scenario.
The final results are in line with the preliminary results published in March 2021 and included assessments of banks’ resilience to climate risks through loans, security and equity holdings.