The European Supervisory Authorities — European Banking Authority (EBA), European Insurance and Occupational Pensions Authority (EIOPA) and European Securities and Markets Authority (ESMA) — together with the European Central Bank (ECB), released the results of the one-off “Fit-For-55” climate scenario analysis.
Under the scenarios examined, transition risks alone are unlikely to threaten financial stability. However, when transition risks are combined with macroeconomic shocks, they can increase losses for financial institutions and may lead to disruptions. This calls for a coordinated policy approach to financing the green transition and the need for financial institutions to integrate climate risks into their risk management in a comprehensive and timely manner.
The European Commission invited the ESAs and the ECB to assess the impact on the EU banking, investment fund, occupational pension fund and insurance sectors of transition scenarios, including: transition risks materializing in the form of “Run-on-Brown” shocks, whereby investors shed assets of carbon-intensive firms and which hampers the green transition, since “brown” firms don’t have the financing they need to green their activities; and the “Run-on-Brown” shocks are amplified with other standard macro-financial stress factors.
The results of the exercise show that estimated losses stemming from a “Run-on-Brown” scenario have a limited impact on the EU financial system. Over an 8-year horizon, total first-round losses stand between 5.2% and 6.7% of starting point exposures, in each sector. The second-round losses are mostly relevant for investment funds, and amount to 11.2% of starting point exposures.
The interaction of adverse macro-financial developments with transition risk factors could disrupt the evolving transition and substantially increase financial institutions’ losses, thereby impairing their financing capacity. This is assessed in the adverse scenario where the “Run-on-Brown” shocks are coupled with adverse macroeconomic conditions.
Under this scenario, the first-round losses registered by banks, insurers, occupational pension funds and investment funds stand between 10.9% and 21.5%, depending on the sector. Although sizeable, the impact of these losses on financial institutions’ capital is expected to be mitigated by factors such as banks’ income, insurers’ and occupational pension funds’ liabilities, and cash holdings by investment funds that were not included in the assessment.