This is the divide that has characterized the euro zone for years: the difference in economic prosperity between the North and the South. During the euro crisis (2011-2013), the Nordic countries ensured the rescue of Greece, Spain, Portugal and Cyprus via support funds. This was followed by a Greek crisis (2015) and, currently, the Corona crisis, which hit countries like Italy and Spain earlier and harder than the Nordic countries, widening further away.

During these crises, the European Central Bank intervened on several occasions to support vulnerable banks and governments. The same European Central Bank on Wednesday spoke of a relatively new financial and economic risk that could worsen the North-South divide: climate change. For the first time, the European Central Bank has conducted climate stress tests on the economy and financial sector in the euro area. Financial and climate data from 1,600 euro area banks and millions of businesses were combined with climate models.

Systemic risk

ECB Conclusion: Climate change is a “major source of systemic risk” for the next 30 years. For all of Europe, but certainly for the south. The European Central Bank says the physical impact of global warming could hit Mediterranean countries hard. Intense heat – think of the temperature of 49 degrees measured in Sicily this summer – water shortages and forest fires increase the risks of damaging production processes and supply routes for companies, which become less profitable or may go bankrupt.

As a result, banks that have granted loans to these companies may also find themselves in difficulty. There are also physical climatic risks in northern and central Europe, in the form of floods like those that occurred last summer in Belgium, Germany and the Netherlands. But that risk is relatively limited for companies there, according to the ECB’s calculations.

The number of companies in southern Europe exposed to “high physical climate risk” ranges from 25% (Italy) to almost 100% (Greece). In northern Europe, it is less than 10 percent. This difference is reflected in the risks for banks identified by the European Central Bank. More than 60% of bank loans to businesses in Greece, Cyprus, Portugal and Spain have been classified as “high physical climate risk” by the European Central Bank. In France, the Netherlands and Germany, this figure is less than 10%.

In addition to physical climate risks, the European Central Bank sees “transformation risks”: due to the energy transition, companies must accelerate the exit from polluting traditional revenue models and production processes, sometimes at high costs. Some fossil fuel companies are disappearing altogether. The write-offs and bankruptcies of these companies also affect the banks that have financed the companies. The European Central Bank has found that this risk applies to northern and southern Europe to roughly equal extent.

Read also: Climate becomes the touchstone of European Central Bank monetary policy

The message from the ECB after the climate stress test is: better to take “quick” and “orderly” action to reduce greenhouse gas emissions rather than wait. Although the costs of relocation are high in the short term – fossil fuel economic activities must be stopped – the physical damage from heat, drought and long-term natural disasters is much less. Delaying climate policy means a ‘messy’ scenario in which drastic measures still have to be taken ‘brutally’ and at a higher cost. The third scenario of endemic climate change (with a global temperature rise of 3 degrees or more) is completely devastating economically. The damage caused by natural disasters would then amount to 10% of euro area GDP in 2100, compared to the scenario in which measures are taken in time.

climate models

These types of scenarios are based on a mixture of climate and economic models and are surrounded by a lot of uncertainty. And although financial and economic authorities are still in the early stages of this type of complex investigation, their message to politicians is consistent:2emissions, avoids major problems later. These include De Nederlandsche Bank, which was previously the Climate Stress TestThe International Monetary Fund publishes it.

Integrating climate risk into the supervision of banks and other financial institutions is even more difficult. For “classic” financial risks, there are bank reserves which were tightened after the 2008/2009 financial crisis, in the so-called “Basel III” regulations. “Basel 4”, with more emphasis, should be introduced soon. But “Basel 5”, in which climate risks are listed, remains to come. The European Central Bank will carry out a second climate stress test next year, specifically for the banking sector. It should pay close attention to climate risk in bank balance sheets.


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Al Worden

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