ECB’s Climate Stress Test: Urgent Green Action Crucial for Financial Stability

A new climate stress test conducted by the European Central Bank (ECB) reveals that banks, businesses, and households could enjoy reduced costs and decreased financial risks by the end of the decade if efforts to cut emissions are significantly accelerated. Conversely, if actions to meet global climate goals are delayed until the latter part of the decade, banks’ credit risk could increase by more than 100% by 2030.

The ECB’s second economy-wide climate stress test assessed the impact of various climate transition scenarios on companies, households, and financial institutions in the Euro area. Three scenarios were considered:

1. Accelerated Transition: This scenario frontloads green investments immediately to achieve emissions reductions necessary to meet the Paris Agreement goal of limiting temperature increase to +1.5ºC by 2030. It assumes a significant increase in energy costs in the near term and substantially greater initial green investments.
2. Late-Push Transition: This scenario also achieves the Paris Agreement goals but delays increased action until after 2025. It involves a catch-up in green investments starting in 2026.
3. Delayed Transition: This scenario is compatible with a temperature increase of around +2.5ºC by the end of the century and represents the slowest transition.

Despite higher initial costs in the accelerated transition scenario, it results in the lowest long-term financial and physical risk. The late-push scenario has the most significant medium-term impact on costs and risk, while the delayed scenario leads to much higher long-term physical risk from climate hazards.

For households, the accelerated scenario results in a rapid increase in energy expenses and investments in renewable energy and energy efficiency. Energy costs peak later in the other scenarios, but by 2030, the accelerated and late-push scenarios result in higher household discretionary income compared to the delayed scenario.

For businesses, the late-push scenario sees higher cumulative investments in renewable energy and carbon mitigation, along with increased credit risk. Companies in energy-intensive sectors face acute risks in this scenario. Credit risk levels vary across scenarios, with the highest risk projected in the late-push and delayed scenarios.

Banks’ credit risk is influenced by the transition effects on companies and households they lend to. Under the late-push scenario, banks’ credit risk could increase by more than 100% by 2030, compared to around 60% in the other scenarios. Credit risk is expected to trend upward only in 2030 under the delayed scenario.