Banks and insurance have key role to play in reducing climate-related financial stability risks, joint ECB/ESRB report finds

The ECB and the ESRB jointly released a comprehensive report addressing the implications of climate change on the EU financial system. The report introduces three frameworks to assess climate risks in relation to financial stability: risk surveillance, macroprudential policy, and broader risks associated with nature degradation.
Indeed, the first framework focuses on financial stability risk surveillance, emphasizing advancements in measuring and modeling climate risk impacts. The report proposes a set of indicators for regular monitoring of financial stability risks. The second framework outlines macroprudential policy options, detailing the features of a robust strategy and an initial operational design based on existing instruments. This design can be expanded as more information becomes available and more tailored policy options emerge. The third framework explores prospective financial stability impacts arising from nature degradation, which may compound the effects of climate change on financial stability.
The report emphasizes the pivotal role of banks in managing and mitigating risks to financial stability resulting from the emissions of the EU economy. Banks, being significant lenders to sectors highly exposed to climate-related risks, face a lending share that is 75% higher than the equivalent share in economic activity. Furthermore, 60-80% of mortgage lending in the euro area is directed towards households with high emissions.
As climate change gains prominence due to increased frequency and severity of climate hazards and concrete plans for a European green transition, the reassessment and repricing of climate risk could induce financial instability. This instability may manifest through global value chains‘ transmission of climate shocks and the potential for financial contagion as both banks and financial markets reposition their asset portfolios.
To address these risks, the report advocates for a robust macroprudential strategy that extends beyond the banking sector to encompass borrowers and non-bank financial intermediation. It highlights the importance of managing risks in insurance protection and information gaps, underscoring the need for reliable disclosures and robust green labels. Existing instruments in the EU macroprudential toolkit, such as systemic risk buffers or risk concentration limits, are suggested to effectively address climate-related financial stability risks in a targeted and scalable manner.
The report delves into the degradation of nature as an additional risk for financial stability. Analysis reveals that 75% of bank loans and over 30% of insurer investments in corporate bonds and equity are in sectors heavily reliant on ecosystem services, particularly those related to water, mass stabilization, erosion control, and flood and storm protection.