Results of the economy-wide climate stress test

The ECB conducted a stress test to assess the impact of climate change on more than 4 million companies worldwide and 1600 banks in the European area over a 30-year time horizon. The objective of developing a centralized top-down climate stress test is to assess the resilience of NFCs and banks in the euro area to transitional and physical risks.

A woman holding wheat in a wheat crop

The ECB's climate stress test is based on three scenarios:

  • Orderly transition scenario : The most favourable scenario in terms of potential economic impact.
  • A Disorderly Transition Scenario : The scenario that assumes late implementation of required climate policy measures.
  • The Hot House Scenario : A scenario with no regulations or policies to limit climate change.

The ECB's stress testing exercise assesses the impact of climate risk on the euro area banking system through the credit and market risk channels.

Probability of default :

  • In a warm scenario, the average PD of the loan book would be about 2.3% by 2050, which represents an increase of 7%.
  • The increase in loan portfolio PDs for an average eurozone bank by 2050 would be more than twice as high in a warm world as in a disorderly transition scenario.
  • Subprime banks that experience the largest long-term increase in PDs relative to 2020 values are domiciled in countries that are more vulnerable to physical risk.  

If policies to transition to a greener economy are not put in place, physical risks become higher and higher over time.

Loss given default :

The modeling of the impact of climate change on the (LGD) of portfolios is based on the micro and macro channels. The micro channel studies the decline in physical collateral that is damaged by physical risk.  The macro channel captures the changes in LGD caused by macro financial shocks, in particular changes in GDP due to transition and physical risk.

Within 30 years, damage to physical collateral will impact LGDs of corporate credit portfolios.

  • Due to the impact of physical collateral damage, banks would experience the largest average increase in their portfolio LGDs in a warm world.  

  • The fact that a higher level of damage to physical collateral seems to dominate is illustrated by the share of physical collateral protection having "similar levels in vulnerable and non-vulnerable countries.
  • The share of loans protected by collateral is extremely heterogeneous across countries, although it averages about 50 percent, most of which is represented by physical collateral.
  • Figure 41 presents the share of loans protected by physical and non-physical collateral at the country level. The countries with the largest exposures are Germany, Italy, Spain, and France.

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