European Central Bank Calls for ‘Deeper Understanding’ of Climate Risks

Climate change could hit bank balance sheets with a knock-on effect on financial stability, the European Central Bank warned on Wednesday.

In a special feature for its semi-annual Financial Stability Review on Wednesday, the ECB said problems will materialize if markets aren’t correctly pricing the risks stemming from extreme weather events and the transition to a low-carbon emission economy.

“A deeper understanding of the relevance of climate change-related risks for the euro area financial system at large is therefore needed,” the ECB said. “Better data availability and comparability and the development of a forward-looking framework for risk assessments are important aspects of this work.”

Global warming is getting increased attention from the world’s central banks. Bank of England Governor Mark Carney and his French counterpart Francois Villeroy de Galhau warned in a joint article last month that policy makers cannot ignore the “obvious risks” related to climate change, urging financial industry and central bank to do more. The U.S. Federal Reserve is also reportedly looking into the issue.

The ECB said weather events were responsible for over 80% of insured catastrophe losses in 2018, and “physical risks, when they materialize, can significantly erode collateral and asset values and have an impact on insurance liabilities.”

The central bank said the transition to a low-carbon-emission economy will affect some companies more than others and therefore expose the banks that are intertwined with the them.

Policy makers need to get a better grip on the scale of that exposure as a lack of reliable and comparable data “could create uncertainty and cause pro-cyclical market dynamics, including fire sales of carbon-intensive assets, and potentially also liquidity problems.”