European Central Bank kicks off historic bank climate test with pledge on capital

Frankfurt: The European Central Bank kicked off an historic review to determine how well lenders can withstand the shock of climate change, but sought to reassure the industry that the exercise won’t directly lead to higher capital requirements.

According to details published on Thursday, the ECB will examine “possible future climate policies and assess both physical risks, such as heat and droughts and floods, and short and long-term risks stemming from the transition to a greener economy.” Banks need to submit their responses from March and aggregate results will be published in July, the ECB said.

Europe is pushing banks to brace for potential losses as the fallout from a hotter planet sends tremors through the wider economy. The ECB has described the test as a learning exercise to gather information. Still, lenders have voiced concerns over the process arguing they don’t have the data they need to provide a reliable picture of the risks they face.

In Thursday’s release, the ECB stressed that the test “is not a pass or fail exercise, nor does it have direct implications for banks’ capital levels,” in its statement.

The central bank said the results will feed into the so-called Supervisory Review and Evaluation Process, “from a qualitative point of view.” As a result, the test “could indirectly impact Pillar 2 requirements,” but “will not directly impact capital through Pillar 2 guidance,” the ECB said.

“The stress test targets specific asset classes exposed to climate risk rather than banks’ overall balance sheets,” the ECB said. “It focuses on exposures and income sources that are most vulnerable to climate-related risk, combining traditional loss projections with new qualitative data collections.”