The European Central Bank (ECB) has released the findings of its second economy-wide climate stress test, revealing that expediting the green transition is crucial for reducing costs and risks for households, firms, and banks in the euro area. The test examined three transition scenarios: an accelerated transition, a late-push transition, and a delayed transition. The results showed that a faster transition benefits firms and households, with increased investment in renewable energy leading to reduced financial risks in the medium term. However, delaying the transition not only increases risks and costs but also hinders the achievement of the Paris Agreement goals.
In the accelerated transition scenario, green investment by euro area firms is projected to reach €2 trillion by 2025, compared to only €0.5 trillion in the other two scenarios. The frontloading of green policies and investment pays off earlier, reducing energy expenses and ultimately boosting profits and purchasing power. On the other hand, in the late-push transition scenario, firms in energy-intensive sectors face higher risks, with debt levels rising and profits falling at a greater rate than the average euro area firm. Banks that lend to these firms are also exposed to higher credit risk if the transition is rushed later on. In contrast, the accelerated transition leads to a smaller increase in credit risk for banks compared to the late-push transition.
Furthermore, delaying the transition or taking no action at all results in even higher costs and risks in the long run. Missing emission reduction targets exacerbates the impact of physical risks on the economy and the financial sector. Accelerating the green transition and implementing more ambitious emission reduction targets through timely and intensive investment is essential for reducing credit risk for banks in the medium term.
The ECB’s economy-wide climate stress test provides valuable insights into the risks and costs associated with different transition scenarios. It complements the ECB Banking Supervision climate stress test, which examines risks at the individual bank level. This holistic approach helps improve understanding of climate-related risks and supports the ECB’s ongoing work to address these risks.