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PB 6/2022: The first ECB bottom-up climate stress test: Dealing with data gaps and methodological challenges
- The ECB’s “SSM Climate risk stress test,” published in July 2022, provides an important step toward integrating climate change related risks into the banking system. A key aim of this exercise is to take stock of the state of individual bank’s climate risk assessment systems. In addition, a bottom-up stress test was conducted, seeking to analyze banks’ potential financial losses related to climate risks.
- The ECB’s exercise highlighted widespread data limitations that may prevent adequate climate risk assessment by individual banks. There is a strong reliance on proxies and sectoral aggregation to compensate for more granular exposures at counterparty level.
- At the same time, the risk assessment covered only a subset of assets on banks’ balance sheets. The assessment of large asset classes, such as government bonds, is still in its infancy and is not part of the picture.
- On the modelling side, we explain limitations stemming from a strong focus on carbon price as the only policy tool and main stressor, as well as the disregard of potential carbon substitution and cost passthrough mechanisms for exposed firms and their balance sheets.
- To overcome these shortcomings, we suggest three ways forward: using a standardized climate neutrality scenario at the firm level; including all relevant assets in the assessment; and filling existing data gaps at counterparty level.