Stress test sobering: Europe’s banks neglect climate risks

The largest financial institutions in the euro zone do not yet have the risks emanating from climate change fully under control. This is shown by the first climate stress test by the responsible banking supervisory authority.

The financial institutions in the euro zone are still largely groping in the dark about the risks that climate change entails for them. Frank Elderson, a member of the Governing Council of the European Central Bank (ECB), criticizes this. He compares the whole thing to driving a car: “You can’t drive in the dark without lights,” says the deputy head of ECB banking supervision. “The banks need better data on climate risks.”

But that is exactly what is lacking. This is shown by the first climate stress test, in which 104 financial institutions from the currency area took part, including Deutsche Bank and Commerzbank. According to the ECB, the majority of banks are not able to adequately calculate climate risks. So far, they have largely relied on estimates, says ECB Director Elderson: “On the other hand, they should obtain more information from their customers in order to properly measure their risk positions.”

Risks worth billions from climate change?

The ECB supervisor calls for banks to give higher priority to climate risks. According to Elderson, they hardly take them into account in day-to-day business, for example when granting loans. And so their customers often include companies that emit a particularly large amount of climate-damaging gas such as carbon dioxide. That in itself is not a problem, according to the ECB. As long as the companies present plans to the financial institutions on how they want to operate more sustainably in the future.

Otherwise, according to the central bank, there is a risk that the banks will be surprised by political decisions towards more sustainability in the economy. Then they are threatened with losses, as well as as a result of natural disasters such as droughts or floods. In the worst case, the 41 largest financial institutions in the eurozone alone could lose 70 billion euros or even more. Which institutes are involved remains open.

German bank representatives and supervisors relaxed

All in all, the German banking industry, which brings together all savings bank and bank associations, considers the effects of climate change on the local banking landscape to be financially manageable. “The published results show that the financial institutions involved do not have to expect any significant losses overall,” it said in a written statement. Anyway, the whole thing is just a learning exercise, without any concrete effects.

Germany’s top banking supervisor, Joachim Wuermeling, a member of the Bundesbank’s board of directors, is also satisfied. The 21 local institutes did well in the climate stress test, he says: “They have developed an awareness that new risks are appearing on their risk map, and that’s good.” They are not more affected by these climate risks than other European banks. Nevertheless, Wuermeling sees a need for improvement in one or the other area and expects the financial institutions to close data gaps and take climate risks more into account in risk management.

Not all climate risks can be recorded

The banks cannot foresee everything anyway, warns Karolin Kirschenmann, banking expert at the Leibniz Center for European Economic Research in Mannheim. “Assuming the C02 price increases rapidly because a government thinks that the 1.5-degree climate target cannot be achieved otherwise, then this can lead to a recession and hit all banks,” says the economist. Assessing such risks is difficult. For this reason, Kirschenmann considers the significance of the climate stress test to be limited.

With a view to the social debate about climate change, she warns that the role of financial institutions should not be overestimated. Of course, they would have to deal more with climate change and its financial consequences in connection with the stress test. And by directing cash flows in a targeted manner, financial institutions could help them transform the economy towards greater sustainability. “But that has to go hand in hand with an ambitious climate and economic policy,” said the banking expert.