“Transition risks alone are unlikely to threaten financial stability. However, when transition risks are combined with macroeconomic shocks, they can increase losses for financial institutions and may lead to disruptions”, according to the ECB and the European financial supervisory authorities (EBA, ESMA, EIOPA) in a report published on Tuesday 19 November.
This report presents the results of a stress test of the financial sector against the ‘Fit for 55’ legislative package, which aims to reduce the European Union’s emissions by 55% by 2030 in order to achieve climate neutrality by 2050.
The simulation by the EU institution and authorities incorporates three scenarios: - a baseline scenario modelling the integration of the 'Fit for 55' package by the financial sector in a favourable economic environment; - an adverse scenario focusing on short-term climate-related risks in the form of asset price corrections triggered by a sudden reassessment of transition risk (known as the ‘run on brown’); - a second scenario, even more unfavourable than the previous one, combines the same climate-related risks with additional macroeconomic stress factors, including geopolitical risk.
Cautioning against the uncertainty associated with the methodology, the authors of the test analyse the direct impact of the three scenarios on the part of the financial sector under scrutiny (110 banks, 2,331 insurance companies, 629 pension funds, 22,000 European investment funds) as well as the second-round effects in the event of contagion to the financial system.
The results disclosed include losses on equity of between 5.2% and 6.7% for the insurance and banking sectors respectively (adverse scenario 1). The overall direct loss for the market segment analysed would be €1.46 billion (5.98%).
Under the second, even more unfavourable scenario, losses would range from 10.9% for the banking sector to 21.5% for pension funds. The direct loss to the financial sector is estimated at €3.87 billion (15.80%).
“Although sizeable, the impact of these losses on financial institutions’ capital is expected to be mitigated by factors such as banks’ income, insurers’ and occupational pension funds’ liabilities, and cash holdings by investment funds that were not included in the assessment”, the authors qualify.
To see the stress test results: https://aeur.eu/f/eeq (Original version in French by Mathieu Bion)