Luis de Guindos, Vice-President of the European Central Bank (ECB), warns of the climate risks that could threaten companies and banks if climate policies fail to meet the challenges. For companies, these climate risks will mean higher costs and/or lower profits, which could even lead to bankruptcy.

If the ECB continues its work on climate risk, it is conceivable that the prudential requirements imposed on banks - notably the minimum amount of capital they must hold - will include a "climate" component. Prudential leverage is also one of the areas identified in the European Commission's Sustainable Finance Action Plan, to explore how the regulator could use the obligations imposed on banks to encourage the economy's transition to a low-carbon model.

In the wake of the 2008 financial crisis, Eurozone leaders decided to create a banking union to complement the monetary union in place since the creation of the euro.

This banking union involves the implementation of two pillars:

• the Single Supervisory Mechanism (SSM), which supervises banks
• the Single Resolution Mechanism (SRM), which ensures the orderly management of any bank failure

As part of the MSU, the ECB conductsstress tests to assess the ability of eurozone banks to withstand financial and economic shocks. The results of these tests enable the European Central Bank to identify the most vulnerable banks and implement the necessary measures to strengthen them, in cooperation with the banks concerned and national supervisory authorities (e.g. the Banque de France).

As a reminder, the objectives of European banking supervision are as follows* :

• ensuring the solidity of the European banking system
• strengthening integration and financial stability
• ensure consistent banking supervision across the euro zone

In addition to traditional financial risks (credit risk, liquidity risk, etc.), the ECB has conducted an initial climate stress test for the entire European economy in 2021.

This test focused on studying the impact of two climate risks on companies and banks: physical risk and transition risk (a third** type of climate risk, liability risk, is set aside in this analysis).

As a reminder, here are the definitions given by Finance For Tomorrow*** :

• Physical Risk corresponds to the direct losses associated with the damage caused by climatic hazards to economic players (examples: increase in the frequency of extreme climatic events - heatwaves - and occurrence of chronic events - long-term rise in temperatures, sea level).
• Transition Risk corresponds to the economic consequences of implementing a low-carbon economic model (e.g. new regulations, consumer behavior, technological innovations, etc.).

To this end, the ECB has compiled several types of information:‍

• ‍Differentclimate and economicscenarios to 2050, produced by a grouping of the world's leading central banks and supervisors, working on the development of green finance and the role of central banks in climate change****(NGFS).

o An early, orderly transition scenario (as early as 2020) thanks to emissions reductions compatible with a 2.0°C trajectory, involving progressive climate policies.

o A disorganized transition based on the late (2030) and abrupt introduction of aggressive climate policies to achieve the 2.0°C target.

o The business as usual where no additional measures are taken and rising emissions lead to a warming of at least 3°C in 2080‍

• ‍Climate data covering companies and banks, enabling us to deduce their exposure to climate risks - climate score, carbon score. This data covers more than 4,000,000 companies (financial statements, CO2 emissions, location of sites, etc.) and 2,000 banks (level of sectoral and geographical exposure).

The ECB believes that an orderly transition scenario is preferable to the other two in order to limit the impact of climate risks on the economy.

In this scenario, where climate policies are introduced rapidly and gradually reinforced, the initial cost of adapting to these measures would be largely offset by a lower cost of physical risk in the medium and long term, compared to other scenarios.

The logic is as follows: invest early in the transition to limit climate change and its negative medium- to long-term impact on the economy.

In addition, the ECB study highlights the geographical and sectoral heterogeneity of climate risk, noting that the most polluting companies and those located in regions most exposed to physical risk (heatwaves and fires in southern Europe, floods in northern Europe, etc.) are significantly more exposed to climate risk (up to 4 times).

The ECB will continue its work and complement these initial results, in particular by examining the impact of climate risk at the level of each bank to identify individual vulnerabilities.

To date, climate risk has been poorly integrated into the risk models of the banks that provide financing to governments, businesses and individuals. However, as political leaders, organizations and citizens become more and more concerned about the urgency of climate change, the financial sector is moving towards taking greater account of these issues.

In addition to the initiatives taken by credit institutions in favor of green financing (to mitigate and adapt to climate change) or the exit from activities that emit the most CO2 (coal), banking supervision could soon analyze the solidity of banks in terms of their exposure to climate risks.

Following this logic, the next stage should see banks managing their climate risks, notably by reducing their exposure to client companies that are too risky from a climate point of view (physical risk or transition risk).

For companies, it is therefore crucial to measure their exposure to climate risks now, to prepare for changes in bank policies, which will gradually integrate the climate dimension into their business strategy.

The first step is to measure its greenhouse gas (GHG) emissions to understand its transition risk. In this way, a company with high CO2 emissions, likely to be penalized by new regulatory constraints, could initiate the necessary changes before seeing banks turn away from it.

At Keewe, we provide our customers with the Photo Carbone digital tool, for an initial assessment of your CO2 emissions or to draw up your regulatory GHG balance sheet.

Contact us at climat@keewe.eu to find out more about