On 27 January 2022, the European Central Bank (ECB) launched a supervisory climate risk stress test to assess how prepared banks are for dealing with financial and economic shocks stemming from climate risk.
In its letter to the CEO of a significant institution, the ECB states that the exercise consists of three distinct modules comprising a:
- questionnaire on banks’ climate stress test capabilities. This will assess how banks are building their climate stress test capabilities for use as a risk management tool;
- peer benchmark analysis to assess the sustainability of banks’ business models and their exposure to emission-intensive companies. The analysis will compare banks across a common set of climate risk metrics. These metrics include how much banks rely on income from carbon-intensive industries and what volume of greenhouse gas emissions banks finance; and
- bottom-up stress test. This will target transition and physical risks and assesses how extreme weather events would affect banks over the next year, how vulnerable banks are to a sharp increase in the price of carbon emissions over the next three years and how banks would respond to transition scenarios over the next 30 years.
The test will use macro-financial scenarios based on scenarios prepared by the Network of Central Banks and Supervisors for Greening the Financial System. From March 2022, banks will submit their climate risk stress test templates to the ECB for assessment.
The exercise will be conducted in the first half of 2022 after which the ECB will publish aggregate results.