The European Central Bank (ECB) and the European Systemic Risk Board (ESRB) have published a joint report on climate change containing three frameworks to ensure effective macroprudential policy about climate risks. The report summarizes the cross-institutional and interdisciplinary project work over the past four years.
Four senior members of the ECB’s project team – Paul Hiebert, Stephan Fahr, Fabio Tamburrini, and Laura Parisi – presented the findings of the climate report in a Policy Web Seminar organized by the Leibniz Institute for Financial Research SAFE together with the Research Policy Network (RPN) of the Centre for Economic Policy Research (CEPR) on 12 March. Loriana Pelizzon, SAFE’s Deputy Scientific Director and Director of SAFE’s Research Department Financial Markets, moderated the event and described the document as “very ambitious.”
The analysis showed that bank loans often go to sectors with high emissions. However, climate risks are underestimated and insufficiently insured, which also increases the risk of contagion and could, therefore, become systemic, Fahr said, explaining financial institutions’ exposure to climate risks. Borrowers and financial intermediaries that are not banks must also be considered. In the case of households, many mortgage borrowers in the euro area are CO2-emitting households.
Managing environmental stability risks through macroprudential policy
The framework presented in the climate report consists of three categories. The first category includes climate-related floods, droughts, and other climate-related shocks, which are analyzed first. The second category comprises transformation risks that companies face as they transition to a low-carbon economy, such as the energy transition, and risks that could lead to sudden revaluations of assets.
The first category includes monitoring and measuring climate shocks, which Stephan Fahr presented at the Policy Web Seminar. He compiled several indicators with his team that assess the impact of climate and environmental factors on financial stability: “Bringing these indicators together in the ECB/ESRB project team, is a unique opportunity to provide to the community a strong push,” said Fahr. Paul Hiebert confirmed: “This gave us the capacities to effectively pool models, data, and expertise.”
“Institutions might not account for all externalities”
Existing measures, such as the ECB’s climate stress test or the requirements for managing climate-related and environmental risks, can be complemented by targeted and scalable macroprudential measures. These measures constitute the second category in the ECB-ESRB Climate Report. A macroprudential framework is needed to address the many uncertainties surrounding climate-related and environmental risks. Hiebert stressed: “Institutions might not account for all externalities in the interplay amongst institutions and in the greater financial space.”
Fabio Tamburrini emphasized the need for a holistic approach and the importance of a unified EU approach to the global problem of climate change. The national authorities and institutions are called upon to do so: “The operationalization of all the options in the EU are already possible within the current framework,” said Tamburrini.
Laura Parisi, who led the working group on the third category of the framework, which deals with other environmental influences on financial stability, gave an outlook on the issues and challenges that should be considered in future risk assessments: “The work on this framework especially allowed us a laboratory approach, the topic is relatively new for central bankers,” Parisi said, “we started with a blank page.” As a result, the project team has developed policy proposals for these topics on how to deal with future nature-related risks.
