Climate Change Risks: EU Banks Expand Their Scenarios

According to a survey by Oliver Wyman and the Association for Financial Markets in Europe, European banks are developing their risk models in order to prepare for climate change. Some even examine the short-term implications of a warmer planet.

The analysis published on Thursday found that 87% (of the banks) have begun conducting their own internal climate stress test every year, some using models that go beyond what regulators require. The survey revealed that there was a consensus among respondents that prior exercises had understated real risks.

Results show that banks are becoming increasingly concerned with the possibility of global warming affecting asset values. The biggest concern is credit risk, particularly for banks that are heavily exposed to the fossil-fuel industry as well as for lenders who have large mortgage books. As they develop their models, some banks also try to model how they would fare if the fossil-fuel industry rapidly lost value.

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The report was based upon an analysis of 15 banks with combined assets of close to €15 trillion ($16.4 billion).

He said that new areas of concern included business liquidity and interest-rate risks in the banking book. The survey revealed that about one third of banks had already modeled for these risks.

Only one third of the banks surveyed currently consider it relevant to discuss climate risk mitigation strategies with their clients.

A report by AFME & Oliver Wyman concluded that a stress test on climate conducted by the European Central Bank 2022 likely underestimated the risks of a warmer planet. The exercise revealed fewer losses than industry experts had anticipated, and did not cause a significant dent to capital buffers.

The report stated that the ECB test had been a “valuable exercise” for learning. The report said that the industry needs better guidelines to prepare banks for the larger range of climate risks.

The report stated that “While the ECB’s good practices guide is a helpful starting point, additional supervisory guidance would help drive greater consistency in the industry by providing further guidance on how banks can build their internal capabilities for stress testing and model building.”