The European Central Bank (ECB) and the European Systemic Risk Board (ESRB) have called on the banking industry to roll out a “robust macroprudential strategy” to help address climate-related risks.

In a new report, the organisations said that banks lend disproportionately to sectors with high exposure to climate-related risk, with the share of high-emitting sectors in bank lending roughly 75 per cent higher than its equivalent share in economic activity. Additionally, the study says that 60 to 80 per cent of all mortgage lending in the euro area is to high-emitting households.

The ECB and the ESRB warn that reassessing and repricing climate risk could create financial instability through numerous channels with high exposure to climate-related risk.

They say that this includes the transmission of climate shocks through global value chains and the potential for “financial contagion” as both banks and financial markets seek to simultaneously reposition their asset portfolios against what they describe as a “significant insurance protection gap”.

The study also explores how the degradation of nature potentially poses additional risks for financial stability.

It found that 75 per cent of EU bank loans and over 30 per cent of insurer investments in corporate bonds and equity are in economic sectors which are heavily reliant on at least one ecosystem service, with particular dependence on services relating to surface and ground water, mass stabilisation and erosion control, and flood and storm protection.

The organisations said a “system-wide” prudential approach would focus on managing risks not only for the banking sector but also for borrowers.

“Moreover, it would tackle risks in non-bank financial intermediation, notably gaps in insurance protection and information, including the need for reliable disclosures and robust green labels,” they added. “It would also complement ongoing microprudential efforts, including ECB Banking Supervision’s work on climate-related and environmental risk.”

The research added that a strategy of this kind could drawn on existing instruments in the EU macroprudential tooklit, including systemic risk buffers or risk concentration limits, which it said could facilitate tackling climate-related financial stability risk in a "targeted and scalable manner".

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