ZEW Banking Expert Karolin Kirschenmann on the ECB’s Climate Risk Stress Test

The European Central Bank (ECB) published the results of its climate risk stress test, which it conducted for the first time for 104 banks in the euro area. Dr. Karolin Kirschenmann, deputy head of the Research Department “Pensions and Sustainable Financial Markets” at ZEW Mannheim, has commented on this matter:

“It had already become apparent in recent days that the result of the ECB’s first climate risk stress test for the banks it supervises would be milder than feared. However, it remains to be seen whether this result will be confirmed in future stress tests with tougher scenarios and a broader coverage of bank portfolios. At least for now, possible additional capital requirements are off the table, which is a good thing. This allows financial institutions and supervisors to focus on the role of banks in transforming the economy towards carbon neutrality without getting caught up in a dispute over capital requirements. Moreover, they can now draw their lessons from the stress test.

The ECB rightly requires banks to integrate their individual climate risks into the risk models. These will become increasingly easier to determine as more data becomes available and the models are further developed. What appears to be much more important, however, are the risks arising from significant macroeconomic events such as persistent heat waves and, in particular, from transitory risks, e.g. an unexpectedly sharp rise in the CO₂ price followed by a recession. These macro risks represent a challenge not only for individual banks, but threaten the stability of the entire banking sector. Not only are these risks much more difficult to assess, but hedging them is also more complicated. Even if a bank has managed its individual climate risks well, in the case of macro risks the entire economy and thus all banks are affected, not least because of their global interconnectedness.

Banks can play an important role in financing the necessary investments to transform the economy. At the same time, the transformation towards climate neutrality and sustainability will not succeed without bold and well-defined climate and economic policies to minimise transitory risks. The financial sector can support the transformation, but it cannot act as a substitute for a lack of or insufficiently ambitious climate policy.”