European banking supervisors have been accelerating in recent times to try to understand the real risks that the continent’s banks face from climate change. The steps that have been taken to try to achieve an estimate that serve as a reference on the real situation of the exposure of financial institutions to the effects that the climate crisis may have on the economy are different. In the latest of these advances, the European Central Bank (ECB) has issued a warning to southern European banks, including Spain, by pointing to them as the most exposed to these risks, which can lead to significant effects on their business .
The bank tests green mortgages before the flood of housing reforms that the recovery plan will bring
The body chaired by Christine Lagarde this week presented the results of some resistance tests It has carried out in recent months, examining the impact of climate change on more than four million companies around the world and 1,600 banks in the euro zone under three different scenarios. The first scenario assumes an orderly transition, with effective policies approved in time to limit the increase in temperature as marked by the Paris Agreement. In this case, the impact on GDP can be contained to just 2%, because it will not be possible to avoid all physical risks for companies.
In the second scenario, a disorderly transition is contemplated, in which the measures are approved late and abruptly. Due to this, the economy will register economic losses both from the costs of the transition and from the effects of climate change on companies. In the third and worst case, no regulation or policy is approved to limit climate change. In this way, by 2090 a 2% increase in GDP will be achieved (due to the absence of transition costs), but this positive impact will be more than offset by the physical damage to companies, which could subtract up to 10% from GDP.
Spanish banks are highlighted in this document for their strong ties to companies that are more exposed to disasters that can cause a disorderly ecological transition (fires, floods, etc.). Specifically, the ECB points out in its report that more than 60% of the Spanish banking portfolio of loans to companies is in companies with a “high physical risk”, only surpassed by smaller economies such as Greece, Cyprus or Portugal. As a comparison, the average exposure of banks in the euro zone is around a third of the data shown for Spain, according to the supervisor. Banks in the euro area could be severely affected if they do not take action on climate change because it would “significantly” increase the losses in their portfolios of loans to companies, adds the ECB.
Fires and floods
The ECB concludes in its analysis of European companies that climate risks are concentrated in certain countries. In fact, he points out that although the threats are similar in all countries, there are some that have “exceptional vulnerability.” And there it places both Spain and Italy. Both countries accumulate more than half of the exposure of European companies to high climatic risks. In the Spanish case, it is mainly fires that accumulate the greatest vulnerabilities, followed by floods.
In this sense, the ECB analyzes the possible impacts for the banking business in the different scenarios that it draws in its analysis, from an orderly transition to a hypothesis in which warming exceeds three degrees, failing to comply with the levels set in the Paris agreement. The agency notes that there is “clear evidence” that an orderly transition would end up having economic benefits. “In the short term, banks would suffer the cost of a green transition; however, this effect reverses in the medium and long term, which points to the economic benefit of an orderly transition,” he says.
The supervisor points out in his report that the other scenarios, those in which companies would be more impacted by adverse climatic effects, would mean a significant increase in the data of default data by these companies, increasing problems for the business banking. This reality would affect, according to the ECB, “significant entities”, which are those that are larger and are usually present in more than one country and that would be more exposed to large companies, with higher debt issues, covered by the banks. The increase in defaults suffered by large financial institutions would therefore be greater than the less significant ones.
“Without policies for the transition to a greener economy, physical risks will increase over time,” said ECB Vice President Luis de Guindos in an interview issued by the body together with the stress test report. Therefore, De Guindos added, it is essential to start the transition early and gradually to mitigate the costs of natural disasters.
Ecological doubts about the bank’s commitments
These types of reports are based on an initial problem recognized by the agency itself and that is the lack of data on the actual exposure of banks and companies to climate risks. In fact, the ECB points out in the aforementioned document that not all the credit portfolios of European banking entities have been included in the study because some of them do not provide all the necessary data to be able to include it in the analysis. In addition, the ECB warns, a study on the impact of the crisis on the financial system must go beyond the banks. Therefore, the agency advances that a similar test will be carried out in investment fund managers and indicates that it could also be useful for insurers.
Other supervisory bodies, such as the Financial Stability Board, have warned over the past year that climate-related risks pose the greatest threat to the financial sector, above any other potential economic distortion. This reality has prompted greater control of banks’ exposure to these risks and a growing pressure for them to adopt policies that limit their presence in certain sectors, those most linked to climate change. Some banks have already announced plans to minimize their activity in sectors such as mining or fossil fuels. However, environmental organizations have questioned these commitments, recalling that large international banks have been increasing financing to these industries since the signing of the Paris agreement.
The ECB itself warned in July of the risk of greenwashing in some of the policies that the financial sector was taking to finance the ecological transition. Specifically, he referred to green bonds, debt issues dedicated to sustainable policies. “Green labeling of debt has had a mixed impact on carbon reductions to date, suggesting that ‘greenwashing’ remains a problem,” he said at the time. On that occasion he was already advancing some of the conclusions that have been exposed in the stress tests published this week, such as that there is a strong concentration of threats because only 25 entities accumulate 70% of the exposure to physical climatic risks.