EU-wide pilot exercise on climate risk

In 2020 the Taxonomy Regulation was published. It provides uniform criteria for companies and investors to determine which economic activities can be considered environmentally sustainable. Additionally, it establishes a common language that these investors will use when investing in projects and economic activities that have a positive impact on the climate and the environment. On the other hand, the revised CRR/CRD package gives the European Banking Authority (EBA) the mandate to develop qualitative and quantitative criteria to assess the impact of Environmental, Social and Governance (ESG) risks.

In this context, the EBA launched in 2020 a pilot exercise on climate risk focused on the identification and quantification of exposures from a climate perspective on transition risk. Following the exercise, the EBA has published the results of EU-wide pilot exercise. As the EU taxonomy and climate risk stress test frameworks are still developing, this pilot was designed as a learning exercise to investigate how existing and newly developed climate risk assessment and classification tools perform, and to test banks’ readiness to deal with related data and methodological challenges.

Executive summary

The EBA has published the results of the EU-wide pilot exercise on climate risk. This has been a learning exercise in which the EBA and the 29 volunteer participating banks explored different tools to categorise exposures that could potentially be vulnerable to climate risks methodological limitations.

Main content

This technical note presents a summary of the exercise and the main results. It is structured in five main sections:

• Portfolio classification. The EBA classified Bank’s exposures using some of the methods currently available and which could be relevant from a climate perspective. In particular, both a sector-based and an emission-based approach were applied.
• Green taxonomy. In a further step, banks were also asked to provide an estimate of the ‘greenness’ or alignment with the EU taxonomy criteria of the exposures within the scope of this exercise (green data classification).
• Scenario analysis. Finally, it was performed a scenario analysis to estimate the possible impact of transition and physical risk on banks’ balance sheets. The analysis was run by applying shocks to risk parameters to measure the impact in terms of expected loss.
• Results. A comparable green asset ratio is constructed and the average ratio across banks is estimated to be 7.9%. Furthermore, the additional expected loss in the two adverse scenarios, disorderly and hot house world, is 160 and 175 bps respectively.
• Next steps. The main findings of the pilot exercise will form the basis of a broader discussion on how to design a climate risk stress test exercise for the EU banking sector.

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