Climate change is one of the greatest challenges facing humankind this century. If
left unchecked, it is likely to result in more frequent and severe climatic events, with
the potential to cause substantial disruption to our economies, businesses and
livelihoods in the coming decades. Yet the associated risks remain poorly
understood, as climate shocks differ from the financial shocks observed during
previous crises. This paper describes the ECB’s economy-wide climate stress test,
which has been developed to assess the resilience of non-financial corporates
(NFCs) and euro area banks to climate risks, under various assumptions in terms of
future climate policies. This stress test comprises three main pillars: (i) climatespecific scenarios to project climate and macroeconomic conditions over the next
30 years; (ii) a comprehensive dataset that combines climate and financial
information for millions of companies worldwide and approximately 1,600
consolidated euro area banks; (iii) a novel set of climate-specific models to capture
the direct and indirect transmission channels of climate risk drivers for firms and
banks.
The results show that there are clear benefits to acting early: the short-term costs of
the transition pale in comparison to the costs of unfettered climate change in the
medium to long term. Additionally, the early adoption of policies to drive the transition
to a zero-carbon economy also brings benefits in terms of investing in and rolling out
more efficient technologies. The results also show that, although the effects of
climate risk would increase moderately, on average, until 2050 if climate change is
not mitigated, they would be concentrated in certain geographical areas and sectors.
When comparing the effects of transition and physical risk, the outcomes indicate
that physical risk would be more prominent in the long run, especially if policies to
transition towards a greener economy were not introduced. Finally, the results
suggest that for corporates and banks most exposed to climate risks, the impact
would potentially be very significant, particularly in the absence of further climate
mitigating actions. Climate change thus represents a major source of systemic risk,
particularly for banks with portfolios concentrated in certain economic sectors and
specific geographical areas.
