By Anders Lorenzen

A study carried out by the European Central Bank (ECB) gave damning verdicts of financial severe risks that will be due to the impact of climate change.

It found that climate shocks could cripple the eurozone economy due to financial interlinkages, amplified dangers and losses.

The study was undertaken with the European System Risk Board, the EU’s risk watchdog. The study warned that climate events would have an abrupt impact on market prices, and would initially hit portfolios of investment funds, pension funds and insurance companies. The effect of sudden repricing would lead to defaults and losses for lenders.

The ECB supervises the biggest banks in the eurozone and monitors 19 countries. It has warned that climate change is a top risk, and strongly advises that lenders acknowledge and reduce their exposures, but so far it has yielded little success.

The report further highlights the damning lack of action from investment banks where there has been no meaningful reduction in emission intensity in the loan portfolios of euro area banks in recent years.  It further states: “exposures to climate-related losses also remain concentrated …, with more than 20% of potential losses residing in the holdings of 5% of euro area banks.”

A cascade of financial tipping points

Further, the report said: “In a disorderly transition scenario, marked by an immediate and substantial increase in carbon prices, respective market losses of insurers and investment funds could potentially amount to 3% and 25% (of) stress-tested assets in the near term.”

The report warns that these market dynamics could amplify each other, and with the impacts of climate change the values of assets could quickly drop leading to mass sell-offs and a downward spiral in valuations. 

And away from the investment community, the report explained that this could also leave households vulnerable. This is almost half of the outstanding home loans that have been made to borrowers who have high ratios of energy costs to income.

Though the report concludes that an orderly green transition would reduce corporate defaults by up to a fifth in 2050.

While this research focused on the eurozone economy, it is likely that similar findings would be found in other geographical areas.