- The European Supervisory Authorities (EBA, EIOPA, and ESMA – the ESAs) together with the European Central Bank (ECB), recently released the results of the one-off “Fit-For-55” climate scenario analysis. The exercise evaluates the financial system’s capacity to support the green transition amidst economic shocks and identifies potential vulnerabilities in banks, insurers, pension funds, and investment funds.
- Scenario Framework: The analysis includes a baseline scenario reflecting full implementation of the Fit-for-55 package, and two adverse scenarios: 1) A sudden reassessment of transition risks causing asset price corrections (""run on brown""); 2) A combination of transition risks and additional macroeconomic stress factors like geopolitical tensions.
- Sectoral Impacts:
1) Banking Sector: Aggregate losses under adverse scenarios range up to 10.9% of total exposures (€638 billion). Losses are primarily driven by increased probabilities of default (PDs) in carbon-intensive sectors, highlighting the need for banks to integrate climate risks into their frameworks;
2) Insurance and Pensions: Investment value declines of up to 18.8% (€1.3 trillion) for insurers and 21.5% (€379 billion) for pensions under the most severe scenario, amplified by high exposure to long-duration bonds;
3) Investment Funds: Losses could reach 15.8% (€1.6 trillion), with smaller funds experiencing significant stress due to reduced diversification and liquidity.
- Systemic Resilience: Despite high initial losses in adverse scenarios, the financial system’s strong capital and liquidity buffers mitigate threats to stability. Smaller entities, particularly funds, are more vulnerable.
- Policy and Operational Gaps: The report identifies critical data and methodological limitations, particularly in modeling second-round effects and cross-sectoral interdependencies. It underscores the importance of dynamic risk management strategies and enhanced data collection.
