Transition risk losses alone unlikely to threaten EU financial stability, climate stress test reveals

Written by Adam Cadle

19/11/2024

Transition risk losses alone are unlikely to threaten EU financial stability, the latest climate scenario analysis conducted by the European Supervisory Authorities (ESAs) and the ECB has revealed.

The analysis found that when transition risks are combined with macroeconomic shocks, however, they can increase losses for financial institutions and may lead to disruptions.

The one-off ‘Fit-For-55’ climate scenario analysis aims to stimulate investment and innovation in the transition to a green economy and plays a crucial role in the EU’s goal to achieve an emissions’ reduction of 55% by 2030 and climate neutrality by 2050. The climate stress test was conducted against three scenarios developed by the European Systemic Risk Board (ESRB), with the support of the ECB.

Under the baseline scenario, the Fit-for-55 package is implemented in an economic environment that reflects the ESCB's June 2023 forecasts, while still facing additional cost related to the green transition. Under the first adverse scenario, transition risks materialise in the form of 'Run-on-Brown' shocks, whereby investors shed assets of carbon-intensive firms. This hampers the green transition, since 'brown' firms don't have the financing they need to green their activities. Finally, under the second adverse scenario, the 'Run-on-Brown' shocks are amplified with other standard macro-financial stress factors.

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