• The “Fit-for-55” climate stress test shows that transition risks alone pose limited threats, with first-round losses of 5.2%-6.7% across EU financial sectors over an 8-year horizon.
• Combined transition and macroeconomic shocks could increase losses significantly, with first-round impacts ranging from 10.9% to 21.5% depending on the sector.
• Coordinated policy action and climate risk integration in financial institutions are critical to advancing the green transition while managing financial stability risks.

Climate Risks and Financial Stability: Key Insights

The European Supervisory Authorities (EBA, EIOPA, and ESMA) and the European Central Bank (ECB) today published findings from the one-off “Fit-for-55” climate scenario analysis. The test, requested by the European Commission, evaluated the impact of transition risks and macroeconomic shocks on the EU financial system under scenarios aligned with the EU’s Fit-for-55 package.

The test revealed that transition risks alone are unlikely to jeopardize financial stability, but combined with adverse macroeconomic factors, they could lead to substantial losses for financial institutions and disrupt the green transition.

Stress Test Scenarios and Results

Three scenarios were modeled by the European Systemic Risk Board (ESRB) with ECB support:

1. Baseline Scenario: Transition risks materialize within a stable economic forecast.
2. Adverse Scenario 1: A “Run-on-Brown” shock, where carbon-intensive firms lose investor support, slowing their transition efforts.
3. Adverse Scenario 2: Amplified “Run-on-Brown” shocks paired with macro-financial stressors.

Results:

• In the baseline scenario, first-round losses were limited to 5.2%-6.7% of initial exposures across financial sectors.
• Under Adverse Scenario 1, investment funds faced the highest second-round losses, at 11.2%.
• Adverse Scenario 2, combining macroeconomic and transition risks, resulted in first-round losses of 10.9%-21.5%, with banks and insurers demonstrating resilience due to unassessed mitigating factors like cash holdings and liability structures.

Implications for Policy and Risk Management

The report highlights:

• The need for coordinated policy action to ensure adequate financial resources for the green transition.
• The importance of integrating climate risks into financial institutions’ strategies to mitigate potential losses.

A Call for Action

The findings underscore the EU’s commitment to achieving climate neutrality by 2050 under the Fit-for-55 package. Policymakers must now balance stimulating investment in green initiatives with managing risks to financial stability.