What are climate stress tests and who carries them out?

Every two years, European banks undergo a stress test by the European Banking Authority (EBA). In 2022, the ECB adds a new test that incorporates climatic criteria. To date, “the European supervisor has several lines of work in progress on this subject, including the periodic evaluation of the guides on the expectations of supervisors and the thematic inspection of banks”, explained Ana Rubio. This year, in addition to this action framework, “the first stress test to assess the resilience of banks to different climate change scenarios will be tested”. It is a process which “is in its infancy”, added Antoni Ballabriga.

What are the tests?

The ECB divided the exercise into three modules: i) a questionnaire on banks’ ability to carry out climate stress tests; ii) benchmarking to assess the sustainability of the bank’s business models and their exposure to the most emitting companies; and iii) a bottom-up stress test. To ensure proportionality, smaller banks will not be required to include projections for stress testing.

Specifically, “the test will use macro-financial scenarios based on those developed by the Network of Central Banks and Supervisors for Greening the Financial System (NGFS). These scenarios reflect possible climate policies in the future and take into account the risks physical conditions such as rising temperatures, droughts and floods, and the short and long-term risks associated with the transition to a greener economy,” the ECB said.

It is therefore, in the words of Ana Rubio, a “very ambitious exercise”, as it includes a qualitative part which focuses on the evaluation of the banks’ internal procedures, a comparative analysis of the banks in terms of sensitivity of their income and their exposure, and an exercise in analyzing the impact of different scenarios on credit portfolios. In addition, it analyzes both physical risks such as those associated with specific drought and flood scenarios, as well as transitional risks that arise more generally from the process of transitioning to a more sustainable economy. Finally, “as this is a new exercise, there are no previous experiences to support us, and different countries and regions are testing with different methodologies, which we believe will eventually converge” , she explained.

When and how will the results be published?

The exercise will take place in the first half of 2022. In March, the banks sent their first models to the supervisor for evaluation. The ECB will publish aggregate data – not bank by bank – in July.

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