For European financial institutions, the shift from “brown” to “green” could also bring losses.Image: trapezoid
Transforming the economy from a “brown” to a “green” economy is a huge challenge. It could also bring losses to European financial institutions. Comprehensive stress testing shows to what extent.
The multibillion-dollar challenge of green restructuring the economy combined with the economic shock could lead to significant losses for European banks and insurance companies. Banking regulator EBA, insurance regulator EIOPA, securities regulator ESMA and the European Central Bank (ECB) came to this conclusion in the first cross-sectoral climate stress test: “In the scenarios studied, the transition is unlikely to occur.” The risk alone threatens financial stability. However, when transition risks combine with macroeconomic shocks, they can increase losses for financial institutions and lead to disruption. “
Using EU climate targets as a starting point
The EU has set a target of reducing emissions of the greenhouse gas carbon dioxide (CO2) by 55% by 2030 compared to 1990 levels. The EU wants to be climate neutral by 2050, which means that from that point on, climate-damaging gases such as carbon dioxide should be avoided or stored. The “Fit for 55” legislative package within the framework of the so-called Green New Deal aims to ensure this. The strategy includes measures in various sectors including energy, transport, industry and agriculture.
Transforming the economy from “brown” to “green” requires billions of dollars. This opens up investment opportunities. But at the same time, climate change is leading to increasing credit risks. Supervisors should determine the degree of resilience of the financial system under the Fit for 55 package and the extent to which financial institutions can support climate-friendly economic restructuring even under stress conditions.
Played several scenes
The stress test period is eight years (2022 to 2030). The consequences of the following three scenarios were assessed for 110 banks, 2,331 insurance companies, 629 corporate pension schemes (e.g. pension funds) and approximately 22,000 EU-based funds:
– The baseline scenario simulates a smooth and timely transition to a low-carbon economy, with the government implementing policies from the “Fit for 55” package. The economy is growing and energy prices are relatively stable.
– The first negative scenario assumes investors divest from assets in carbon-intensive companies as climate risks are reassessed.
– In the second negative scenario, macroeconomic stressors exacerbate the decline in certain asset prices. For example, suppose natural gas and carbon prices rise significantly.
Billions of dollars of losses are coming
According to the regulator's calculations, in the worst-case scenario, banks' credit and market losses could be as high as 638 billion euros, or 10.9% of the exposures considered. For insurance companies, in the second negative scenario, the value of their investments would fall by 18.8%, or €1,285 billion; for pension funds, the value of their investments would even fall by 21.5% (€379 billion).
Deutsche Bank and Commerzbank, Landesbanken BayernLB, Helaba, LBBW and NordLB, DZ Bank and Deka Bank from Germany, as well as Hamburger Haspa, Germany's largest savings bank, must take part in the test. The results should not have any impact on financial institutions' capital requirements. (Sudan Development Authority/Africa Working Group/Department of Political Affairs)
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