The challenge of climate change is daunting. This is certainly true for the consequences if climate change continues unabated, such as increased natural disasters and the loss of habitats and biodiversity.
It is a great honour for me to be with you today to discuss the role
of banks in greening the economy. And I am very happy to delve into the
topic of climate change at an event co-organised by the European Bank
for Reconstruction and Development (EBRD) – an institution whose own
work remarkably exemplifies what international cooperation can achieve
in supporting the greening of the economy. Your commitment to meeting
the goals set under the Paris Agreement is outstanding. It offers great
inspiration to all of us in European institutions who are just as
adamant about doing the same. As many of you know, climate change
considerations feature prominently in the ECB’s ongoing monetary policy
strategy review. But today I will focus on how they will be taken into
account by ECB Banking Supervision.
The challenge of climate
change is daunting. This is certainly true for the consequences if
climate change continues unabated, such as increased natural disasters
and the loss of habitats and biodiversity. And it is also true for the
transformation necessary to avoid these dire consequences. The OECD
estimates that global investments of USD 6.9 trillion every year are
required until 2030. And that is just to keep us on track to limit
global warming to 2 degrees Celsius above pre-industrial levels.
Investment will need to be considerably higher than this USD 6.9
trillion figure if we are to live up to our commitment under the Paris
Agreement of limiting the increase in global temperatures to 1.5
degrees. To put this number into perspective: we are talking somewhere
around 8% percent of global GDP each year.
Europe’s financial
system is largely bank-based, so banks are playing a pivotal role in
greening the economy. But what is the supervisor’s role in this process?
The ECB aims to ensure the safety and soundness of the banks we
supervise. Climate change creates material risks for banks, so it is our
job to ensure that the banks under our supervision address these risks
adequately and proactively.
Regarding the risks emanating from
climate change, our sole aim is to live up to our mandate. There is a
knock-on effect of doing so, however, but it is a welcome one. By
compelling banks to adequately assess and manage climate-related risks,
we are, in effect, safeguarding the financing of the transition to a
low-carbon economy as well. If banks proactively manage climate-related
risks, they will not be blindsided by stranded assets, meaning that
capital will be preserved and can be used to finance investments in the
low-carbon transformation. And climate-related risks being adequately
represented on banks’ balance sheets will contribute to these risks
being appropriately priced. So if ECB Banking Supervision recognises the
financial risks emanating from climate change, this will have a dual
effect – it will compel banks to take these risks into account, which in
turn will induce companies and households to factor them in as well.
This alone will not fully internalise the damage caused by greenhouse
gas emissions; other institutions are in charge of making sure of that.
But it is an important piece of the puzzle.
The urgency to act – climate change is irreversible
The
EU has committed to becoming carbon-neutral by 2050. The change that
our economies need to undertake must be structural. We must reduce the
use of fossil fuels as quickly as possible and move towards greener
infrastructure that can support the global economy in a way that is
sustainable and that protects our planet’s ecosystems and biodiversity.
Much
has been made of the dip in carbon emissions that resulted from the
economic shutdown in 2020 in many countries. But to reach the Paris
target, every single year we need reductions in emissions that are
greater than last year’s, and we need to bring about these reductions by
ramping up the use of clean technologies, not by shutting down our
economies. Unfortunately, even the too-small drop in emissions we saw
last year seems set to be all but reversed in 2021. The International
Energy Agency expects to see the second-biggest increase in carbon
emissions in history this year, eradicating 80% of the 2020 reductions.
The good news is that 2021 may also provide just the kind of momentum
we need to tackle climate change effectively. As the European Union and
national governments start making large investments to pave the way for
recovery, it is crucial that those funds are channelled towards
activities that support our transition to a greener economy.
I
will now discuss ECB Banking Supervision’s latest initiatives to ensure
that banks adequately manage climate-related risks. This is our mandate.
As I said earlier, this will also have the positive knock-on effect of
inducing banks, and thus companies and households, to factor in climate
effects when allocating funds. And this will help accelerate the
reduction of carbon emissions – all the way to zero by 2050 at the
latest.
How ECB Banking Supervision is tackling climate risk
Climate risk can affect banks through different channels.
As
I am sure many of you already know, the main risk drivers for banks are
physical risks and transition risks. Physical risks include all those
resulting from a changing climate, from more frequent extreme weather
events and gradual changes in climate, to environmental degradation,
such as air, water and land pollution, water stress, biodiversity loss
and deforestation. For example, extreme weather events – which have been
steadily increasing over recent decades
– can harm borrowers’ ability to repay their debts and thus make the
loan portfolios of banks much riskier. These risks can be further
heightened if extreme weather events also depreciate the value of the
assets used as collateral in those loans.
Transition risks, on
the other hand, include the financial losses that can directly or
indirectly result from the process of adjusting to a low-carbon and more
environmentally sustainable economy. This adjustment could be triggered
by legislation, such as carbon pricing or the banning of
carbon-intensive activities. Even independently from that, consumer
preferences could shift towards goods and services that are more
climate-friendly. An ECB initial assessment confirms that an abrupt
transition to a low-carbon economy would have a severe impact on
climate-sensitive economic sectors, with consequences for up to
one-tenth of banking sector assets if the creditworthiness of the
highest carbon emitting firms is reassessed, and affecting more than
half of banking sector assets if entire economic sectors are reassessed.
And preliminary results from our ongoing climate stress test show that
without further policy action, companies will face substantially rising
costs from extreme weather events. This will greatly raise their
probability of default.
Both
physical and transition risks will become increasingly material for
banks in the coming years, and ECB Banking Supervision has identified
climate change as one of the key risk drivers for the European banking
sector. In line with this assessment, we are taking steps to increase
our understanding of the impact of climate change from a financial
perspective and to ensure that banks fully incorporate these risks into their processes and practices.
I will now go through the recent and ongoing climate-related initiatives related to our supervisory work....
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