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Climate resilience

A climate disaster costs major banks in Europe tens of billions, says the European Central Bank.

The vulnerability of Banks 

A climate disaster costs major banks in Europe tens of billions, says the European Central Bank. The ECB draws this conclusion from the results of the first climate stress test by the ECB's banking supervision department. A combination of drought, heat, flooding and a “disorderly transition scenario” could cause EUR 70 billion in loan losses and capital losses.
By a “disorderly transition scenario”, the ECB means that the climate measures will not be introduced gradually, but that the governments must take sudden interventions, resulting in, for example, a very sharp increase in the price of emission rights. 

 

Emission rights

Banks are exposed to climate risks in various ways with respect to emission rights. More than half of their corporate loans are with companies that emit greenhouse gases. The price of emission rights is a factor that partly determines the repayment capacity.

Floods can have serious consequences for the mortgage portfolio of the banks. If real estate loses its value due to flooding, the banks have less collateral for real estate loans. Heat and drought also pose risks, for example regarding loans to companies. Repeated crop failures, for example, can put farms in trouble. Some climate risks, such as the risk of flooding, are strongly geographically determined.

 

Findings

This is the first time that the ECB has examined the climate resilience of major banks, concluding that there are substantial gaps in data and procedures. It appears that many banks do not yet have well-defined ways of mapping climate risks of assets.

The ECB affirms that the loss of value of 70 billion is still an underestimate. First, the financial institutions fail to consider the inevitable cyclical consequences of a climate disaster. Second, the models are not yet perfected enough to accurately estimate the impact. The authors of the stress test believe that they have only been able to identify part of the real risks.

Finally, no thought has been given to linking capital requirements to climate risks. 

 

Challenges for private bankers

Following the latest evolution of MIFID II (as of the 2nd of August 2022), one of the challenges that private banks are facing today is the ability to offer tailor-made sustainable investment solutions to clients.
In addition, due to the pandemic clients and private bankers travel less. Digitalization instead is continuously increasing with a higher focus on real client needs and desires, including sustainability requirements. 

Hence, combining digital banking capabilities with personal advisory services is key for private bankers to successfully serve their clients, particularly the new generations who are in the pursuit of a better world.

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