ECB: Climate change could trigger next financial crisis

The European Central Bank (ECB) and the European Systemic Risk Board (ESRB) examine how ‘climate shocks’ could affect the European financial system in a new report. Their findings show that climate risks can spread quickly and harm businesses and banks. This shows that climate risks are systemic in nature: a chain reaction can develop that threatens the stability of the financial system.

Read the report Here.

Disruptive CO2 pricing

For example, rapidly rising CO2 prices can cause problems for companies. As a result, they cannot meet their obligations to financial institutions. In addition, climate-related issues such as water scarcity, heat stress and forest fires can reverberate through the financial sector, when parties fear their stocks will devalue and sell them wholesale.

According to the ECB and ESRB, the risks are too great to justify the policy. In the report, they assess various options for tightening the rules. One of these is the adjustment of existing systemic risk buffers. This is the cash that financial institutions need to keep on hand to cover possible losses.

read more: New Zealand introduces first climate law for financial sector

Invest less in risky areas

The report also mentions ‘concentration limits’. These should encourage banks to reduce their investments in carbon-intensive sectors or risky geographies. ‘Exceeding the threshold could lead to increased supervisory oversight’, write the ECB and ESRB in the report.

In this report, the ECB and the ESRB mainly examined the impact of climate-related risks on the European financial system. In addition, they assessed possible policy solutions to mitigate these risks. Their advice is likely to become more compelling in the future. “The emphasis will shift to strengthening the evidence-based arguments for policy action in the EU in the future,” the report said.