Banks' preparedness across key components of climate risk stress-testing frameworks (Module 1, per block)

Industrial Metals Outlook: Assessing the Impact of China's Stimulus Measures

Banks' preparedness across key components of climate risk stress-testing frameworks (Module 1, per block)

Source: ECB (2022 climate risk stress test – Findings on bank's climate risk stress-testing capabilities), ING
Source: ECB (2022 climate risk stress test – Findings on bank's climate risk stress-testing capabilities), ING

Data availability remains a key issue for climate risk stress testing

One of the main challenges with climate change stress testing is data availability. Some 23% of banks with no climate stress-testing framework in place indicated that data was a challenge. Also, banks indicate that data, for example on clients’ climate strategies and targets or the exact location of clients’ premises, was not available to the relevant business areas of the bank.

The ECB notes that one of the objectives of the whole exercise was to make banks enhance their data infrastructure and collection of the relevant data breakdown of exposure and income items. In this round, banks were allowed to use proxies for Scope 1, 2 and 3 emissions and EPC data.

Many companies do not disclose emissions data currently, and banks have made widespread use of the option to use proxies for collecting emission data. For example, around 70% of the Scope 1 and 2 emissions data was based on a proxy rather than on the actual data, while for Scope 3 emissions, over 80% of the data was based on a proxy instead of the actual thing.

The usage of various techniques for collecting the emissions data results in a high dispersion of the data reported even for the same counterparties. Also, obtaining the proper EPC labels was challenging as 65% of banks had to utilise some type of proxy for obtaining the labels, such as the construction year or energy costs of the building. Furthermore, banks were unable to allocate 17% of the mortgages into an EPC label category.

The ECB urges banks to invest more in data collection, to step up their customer engagement and become less dependent on using proxies, to allow for proper counterparty assessments that can be used for climate stress testing purposes. 

Relative use of actual counterparty data vs proxies for reporting Scope 1, 2 and 3 emission data (all sectors)

Source: ECB (2022 climate risk stress test – Findings on bank's climate risk stress-testing capabilities), ING
Source: ECB (2022 climate risk stress test – Findings on bank's climate risk stress-testing capabilities), ING


The 2022 climate stress test was performed as a constrained bottom-up stress test, for which the participating banks provided their own data submissions and stress test projections, subject to a common methodology and a common set of scenarios. The methodology was based on three distinct modules:

  • Module 1: A qualitative questionnaire aiming at assessing the internal climate risk stress-testing frameworks of banks;
  • Module 2: Stock take on two climate risk metrics: 1. The sensitivity of banks’ income to transition risk, and 2. Bank exposures to carbon emission-intensive industries (22 high climate impact sectors representing 90% of GHG Scope 1 emissions in Europe);
  • Model 3: Bottom-up stress test, where banks provided projections for different scenarios and risk areas, covering both physical and transition risks.
    • Physical risk: 1. Drought and heat scenario; 2. Flood risk scenario
    • Transition risk: 1. Three different long-term (30 years) climate policy paths (dynamic balance sheet adjustments): a. an orderly transition, b. a delayed disorderly transition and c. a ‘hot house world’ with unchanged policies. 2. Short-term three-year horizon (static balance sheet).

Modules 1 and 2 were tested across 104 significant institutions, assessed as part of the regular climate risk assessments and subject to the EBA’s new Pillar 3 requirements. Only 41 significant institutions participated in module 3, applying the proportionality principle and factoring in the different levels of preparedness of the banks.

Module 3 Scenarios and risk dimensions used in the bottom-up stress test

Source: ECB, ING
Source: ECB, ING

Bank exposures to climate risks

The 2022 stress test was more of a learning exercise to determine whether European banks could assess their vulnerabilities to climate change rather than to offer concrete conclusions on the actual climate risks that the banks are exposed to, which would be taken into consideration by the ECB when setting additional capital requirements. Drawing such hard conclusions would have been difficult to begin with, considering the data challenges the banks are still facing when it comes to measuring climate risks. As discussed above, most banks still heavily rely on proxies to measure, for instance, the Scope 1, 2 and 3 emissions of their counterparties, with diverse outcomes. This illustrates not only the importance of further customer engagement, according to the ECB, but also the applicable boundaries when it comes to interpreting the results of the stress test.

That said, the ECB was able to draw some insightful conclusions, including from its analysis on the sensitivity of the European banking sector’s income to transition risks, and its exposure to carbon-intensive sectors under module 2:

  • The banks participating in the stress test, by the end of 2021, generated more than 60% of their interest income from business with non-financial corporates belonging to the top 22 most carbon-intensive sectorsThese 22 industries represent just 54% of the overall EU economy. Among these greenhouse gas-emitting sectors, the largest share of income was, however, attributable to sectors with relatively lower intensity, such as real estate activities. Global systemically-important banks were among the group of banks less reliant on income from these sectors, while small domestic retail lenders were among the most reliant.
  • However, to assess banks’ exposure to carbon-intensive sectors, the exposure-weighted average of the GHG emission intensity, based on Scope 1, 2 and 3 emissions was computed. The seven highest GHG emitting sectors are: 1. mining and quarrying, 2. manufacturers of coke and refined petroleum products, 3. manufacturers of non-metallic products, 4. electricity, gas, steam and air conditioning supply, 5. water transportation, 6. manufacturers of chemical products, and 7. metal products. These sectors represent 28.8% of the 22 sectors considered, but account for more than 50% of the carbon intensity of the corporate portfolios of banks. G-SIBs and universal banks then hold the largest share in the seven most carbon-intensive industries, and thus have the highest corporate portfolio carbon intensity.

Furthermore, in relation to the bottom-up stress test under module 3, the short-term disorderly scenario projects banks reported and indicative losses at €53bn, and €17bn losses under the short-term physical scenarios (drought & heat risk and flood risk). The ECB believes the reported €70bn in aggregate losses may significantly understate the actual transition risk, as the climate shock scenarios were not accompanied by an overall economic downturn, while the included exposures only account for one-third of the total. Besides, the climate risk modelling capacity of banks is still at a preliminary stage. What is clear though, is that banks do stand to benefit from an orderly green transition, as this will lead to lower loan losses for banks than a disorderly or inactive transition.

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This publication has been prepared by ING solely for information purposes irrespective of a particular user's means, financial situation or investment objectives. The information does not constitute investment recommendation, and nor is it investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument. Read more

Industrial Metals Outlook: Assessing the Impact of China's Stimulus Measures

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