Banks, businesses and households would benefit from lower costs and reduced financial risks by the end of the decade if actions to reduce emissions were substantially accelerated, according new climate stress test results released by the European Central Bank’s (ECB), which found that banks’ credit risk could rise by more than 100% by 2030 if initiatives to hit global climate goals are pushed off to the second half of the decade.

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The ECB’s findings were published with the results of its second economy-wide climate stress test, following the first stress test in 2021, aimed at assessing the impact of various climate transition pathways on companies, households, and financial institutions in the Euro area.

For the new stress test, the ECB considered three climate transition scenarios, including an “accelerated transition,” which frontloads green investments immediately in order to achieve emissions reductions by 2030 necessary to achieve the Paris Agreement goal of limiting temperature increase to +1.5ºC; a “late-push transition,” which still achieves the Paris Agreement goals, but delays an increase in action until after 2025, and; a “delayed transition,” compatible with a temperature increase of around +2.5ºC by the end of the century.

The accelerated transition scenario assumes a significant increase in energy costs in the near term, and substantially greater initial green investments, rising to €2 trillion by 2025, compared to only €0.5 trillion in the other.

Despite the higher initial costs, however, the stress test found that the “accelerated” transition scenario resulted in the lowest financial risk and lowest physical risk in the long-term, with the “late-push” scenario resulting in the most severe medium term impact on costs and risk, and the “delayed” scenario leading to much higher long-term physical risk from climate hazards.

For households, the accelerated scenario shows a rapid increase in energy expenses and investment, compared to slower growth under the other scenario, as near-term investments are made in renewable energy and energy efficiency, resulting in increased near-term credit risk, with higher debt levels incurred to cover the investments. Energy costs under the other scenarios surpass the accelerated scenario in 2025, however, peaking around 2028 under the late-push scenario, and continuing to rise beyond 2030 in the delayed scenario. By 2030, the accelerated and late-push scenarios find household discretionary income rising by between 10% – 12%, compared to only half as much under the delayed scenario.

For businesses, while renewable capacity levels in 2030 would be similar under the first two scenarios, overall cumulative investments in areas such as renewable energy and carbon mitigation would be higher under the late-push scenario, and firms would be at higher risk under this scenario as well, as the catch-up in green investments would need to increase swiftly from 2026. These risks would be particularly acute for companies in energy-intensive sectors such as manufacturing, mining and electricity. While credit risk levels were found to be similar in 2030 under the accelerated and delayed scenarios, they are also forecast to be moving in opposite directions, with credit risks on the way down under the accelerated scenario and heading higher beyond 2030 under the delayed transition.

The impact on banks’ businesses would largely be a result of the transition effects on the companies and households which they loan to. The stress test results estimated banks’ credit risk rising by more than 100% by 2030 under the late-push scenario, compared to around 60% under the other scenarios, while credit risk is expected to be trending up in 2030 only under the delayed scenario, with “substantially different” long-term risk implications for the delayed transition.

ECB Vice President Luis de Guindos said:

“Procrastinating may be easier and less costly today, but means we will pay a higher price tomorrow: the damage to our environment and economies from rising temperatures will be much more severe. In fact, the sooner and faster we complete the necessary green transition, the lower the overall costs and risks. This is one of the main outcomes of our second economy-wide climate stress test.”

Click here to access the stress test report.

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