Banks and insurance play a key role in reducing climate-related risks to financial stability, joint ECB/ESRB report finds

December 18, 2023

  • Banks are significantly exposed to high-emitting firms and households, with future climate risks undervalued and underinsured
  • Macroprudential policy can control systemic risk with existing tools and complement microprudential efforts
  • Heavy economic dependence on natural ecosystems can exacerbate climate-related risks to financial stability

The European Central Bank (ECB) and the European Systemic Risk Board (ESRB) today published a joint report on the impact of climate change on the European Union (EU) financial system. The report sets out detailed frameworks for addressing risk to the financial system by (i) gathering evidence on the most important indicators of financial stability through a monitoring framework and accompanying table, (ii) using this evidence to develop a macroprudential strategy to address climate risk, and (iii) broadening the scope from climate-related risks to broader nature-related risks.

Banks have a key role to play in the financial system when it comes to managing and mitigating risks to financial stability arising from the emissions of the EU economy, the report found. This is because banks lend disproportionately to sectors with high exposure to climate-related risk. The share of high-emitting sectors in bank lending is about 75% higher than its equivalent share in economic activity, meaning that these sectors are overrepresented in bank lending. Similarly, 60-80% of all mortgage loans in the euro area are to high-emitting households.

Climate change is an increasingly important topic, not only because of the already visible increase in the frequency and severity of climate hazards, but also because plans for a European green transition are becoming more concrete. The reassessment and reassessment of climate risk can create financial volatility through multiple channels with high exposure to climate-related risk. This includes the transmission of climate shocks through global value chains and the potential for financial contagion as both banks and financial markets simultaneously seek to reposition their asset portfolios amid a significant gap in insurance protection.

The report makes the case for a robust macroprudential strategy to address these risks. A system-wide prudential approach would focus on managing risks not only for the banking sector but also for borrowers. In addition, it will address risks in non-bank financial intermediation, in particular gaps in insurance protection and information, including the need for reliable disclosures and robust green labels. It would also complement ongoing microprudential efforts, including the work of banking supervision at the ECB on climate and environmental risks. This approach could build on existing tools in the EU macroprudential toolbox. In particular, systemic risk buffers or risk concentration limits could facilitate addressing climate-related risk to financial stability in a targeted and scalable way.

The report also examines in detail how the degradation of nature potentially poses additional risks to financial stability. An in-depth look at the exposures of financial institutions in the EU suggests that 75% of bank lending and over 30% of insurers’ investments in corporate bonds and equity are in economic sectors highly dependent on at least one ecosystem service, with a particular dependence on services, related to surface and groundwater, mass stabilization and erosion control, and flood and storm protection.

The report follows three previous ECB/ESRB reports on climate risk and is part of the ECB’s wider response to climate change.[1] From a prudential perspective, this includes the ECB’s latest economy-wide climate stress test and its climate and environmental risk management expectations for supervised banks.

For media inquiries please contact Clara Martin Marquezphone: +49 173 379 0591.

Notes

  • The European Commission’s Joint Research Center (JRC) also made a significant contribution to this report. Further information on the JRC’s research on climate and biodiversity financial risks is available on their website.

Leave a Comment

Your email address will not be published. Required fields are marked *