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The ECB rejects the euro area: unprepared for climate risk

Europe’s financial interconnection can become a convenient highway for climate risk

(Sustainabilityenvironment.com) – The financial interconnection of Europe can become a convenient highway for climate risk, amplifying its effects and making them more widespread. It affects both the banking sector and companies. And in the Eurozone no credit institution is taking countermeasures even remotely adequate. This is underlined by a new report by the European Central Bank and the European Systemic Risk Board.

Two dynamics to keep under the microscope. Firstly, in the 19 countries that adopt the single currency, the connections between banks and companies are dense, a precondition for cascading effects. Especially since financial players are not reducing their exposure to climate risk. Second, the concrete possibility that more climate disasters occur concurrently, amplifying the weight of climate change. For example, a combination of water stress, extreme heat and fires – not far from the current situation in much of the continent.

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Despite the warnings issued by the ECB in recent years, “there has been no significant reduction in the intensity of issues in euro area banks’ loan portfolios”, the report says. In some situations that are particularly critical. Among banks, “exposure to climate-related losses also remains concentrated, with more than 20% of potential losses residing in the holdings of 5% of euro area banks“.

Against this background, the report outlines a plausible scenario to show how a financial crisis linked to or triggered by, climate risk can begin, widen and mature. “First, unforeseen climate shocks could have a sudden impact on market prices, initially affecting the portfolios of investment funds, pension funds and insurance companies,” writes the ECB. “Secondly, this sudden reprocessing could cause companies to default, resulting in losses for exposed banks. In a disorderly transition scenario, characterized by an immediate and substantial increase in carbon prices, the respective market losses of insurers and investment funds could potentially amount to 3% and 25% on assets subjected to stress tests in the short term”.

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