Banks Ignore Transition Risk at Their Own Peril, ECB Warns
From supply shocks to financing fossil fuels, it’s becoming riskier for businesses to ignore climate change. For companies and banks that don’t adapt, the results could be painful.
Today’s newsletter looks at how climate risk is already shaping markets, according to separate findings from the European Central Bank and the Central Bank of Ireland.
Meanwhile, Davos kicks off today with climate low on the agenda, after organizers promised the White House they would downplay the issue in order to ensure US President Donald Trump’s attendance.
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Climate takes it to the banks
For years, climate experts have insisted that markets will naturally push companies to take climate change more seriously as risks become more apparent. Fresh research indicates that borrowers are starting to face a financial penalty for ignoring the dangers ahead.
This month, a paper published by the European Central Bank found that banks with the greatest so-called transition risks now “face significantly higher borrowing costs” in funding markets. That followed a December paper by analysts at the Central Bank of Ireland, which showed that companies facing physical climate risks are in a similar predicament, and will need to provide more collateral.
The studies examined the two main ways companies should, theoretically, feel the pain of global warming. Transition risk — the notion that companies slow to cut high-carbon activities will be punished by regulators and markets — has often seemed difficult to quantify, in part because many governments keep delaying efforts to move toward net zero emissions. But physical risk — which covers the real-world impact that extreme weather has on assets such as buildings — is getting harder to ignore as climate disasters mount.
“These papers illustrate well how the economics of the transition is working on a micro-, day-to-day level in the financial system,” said Ulf Erlandsson, chief executive of the Anthropocene Fixed Income Institute.
Margherita Giuzio, a senior economist at the ECB, along with Bige Kahraman and Jasper Knyphausen of the Oxford Saïd Business School, explored how banks’ exposure to carbon-intensive borrowers affects funding costs in the European repo market. (The repo market allows banks to manage short-term cash by selling and then buying back high-quality securities such as government bonds, often overnight.)
The researchers combined data on European banks’ 2019-2022 repo borrowings with information on their financed emissions (the carbon footprint of firms’ capital allocations). They found that banks with higher financed emissions consistently pay more to borrow on the repo market. Specifically, an increase of one standard deviation in financed emissions translates into repo rates that are 7% to 12% higher on average, they said.
The study “provides the first evidence that climate risks affect the pricing of bank liquidity in Europe’s core funding market and highlights how climate transition risks can amplify financial fragilities and interplay with monetary policy transmission,” the researchers wrote.
“Banks are exposed to the economic conditions of the firms they lend to, because shocks affecting those firms can influence their ability to repay loans,” Giuzio said in an emailed response to questions. “Transition risk, for example arising from changes in carbon pricing, regulation, or consumer preferences, can affect firms’ costs and profitability, and therefore their credit risk.”
Yet some financial supervisors have argued that climate change doesn’t pose a threat to financial stability. Differences of opinion sparked tense exchanges between top officials from central banks and finance ministries at a meeting of the Financial Stability Board last year, with US representatives arguing that monitoring climate risk should only be a focus if there’s proof it poses an imminent threat to the financial system.
Meanwhile, Ireland’s Central Bank found that the physical fallout of climate change is feeding through to borrowing costs across sectors. After looking at 40,852 corporate loans in the country, the central bank found that companies located in areas at risk of flooding pay about 7 to 13 basis points more than peers who don’t face such risks.
What’s more, the central bank’s researchers said the number of loans exposed to flood risks “is predicted to increase significantly due to the expected patterns of climate change.” The study also found that businesses in flood zones are more likely to back loans with collateral.
Another recent paper from the Frankfurt School of Finance & Management looked at climate risk through a much wider geographic lens. Written by Karol Kempa and based on a global dataset of around 86,000 syndicated bank loans, the Frankfurt paper showed that firms from countries with “higher climate vulnerability” face higher borrowing costs. More specifically, a single standard deviation in climate vulnerability corresponds to a 39 basis-point increase in borrowing costs, Kempa wrote.
“Climate related events could cause substantial economic damages to firms,” he said. And that “could be transmitted to the financial sector via loan defaults and drops in asset prices, and ultimately stress financial stability.”
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Renewable revenue
Inescapable impacts
“It is undeniable now that climate change is having significant effects on the drivers of the economy.”
Sarah Bloom Raskin
Professor, Duke Law School
The US has run up about $7.7 trillion in climate-related costs since 2000, according to Bloomberg Intelligence research, making it a key part of the economy.
This week’s Zero
Ever since the Paris Agreement was signed in 2015, governments have been trying to nudge big financial players to move more money into climate solutions. The idea was to drive action through data disclosure and net-zero goals, but that hasn’t yielded the results they hoped for. Have they got their approach to climate finance wrong? Lisa Sachs, director of Columbia University’s Center on Sustainable Investment, makes the case this week on the Zero podcast.
Listen now, and subscribe on Apple, Spotify or YouTube to get new episodes of Zero every Thursday.
Davos goes quiet on climate change
By Laura Millan
There was a time when climate action, extreme weather events and biodiversity loss were the top worries of the world’s rich and powerful descending on Davos for the annual World Economic Forum. Not anymore.
This year, in order to guarantee US President Donald Trump’s attendance at the gathering in the exclusive Swiss mountain resort, organizers promised the White House they would downplay climate change and other topics that Trump considers “woke.”
When asked to rank the severity of global risks over the short term, over 1,300 leaders and experts responding to a WEF survey put extreme weather events in the fourth place, with geo-economic confrontation, misinformation and disinformation, and societal polarization topping the list. In previous editions of the survey, extreme weather ranked second.
This year’s climate-related events at Davos include panels on electric vehicles, energy security, nuclear power plastics and climate finance. Check the full agenda and follow Bloomberg’s live coverage.
More from Green
President Donald Trump’s campaign against offshore wind power in the US sustained major setbacks last week when three different judges blocked enforcement of a government ban and allowed projects in New York, Rhode Island and Virginia to resume construction. And two others may win similar decisions soon.
But Trump may already have won his battle to gut the industry, even if the turbines now under construction begin supplying electricity as planned in the next year or so. That’s because the dramatic shift in US government policy since Joe Biden was president has escalated the risk of investing in multibillion-dollar projects that already were facing significant financial and technical hurdles.
China’s coal production reached a record last year, even as the country’s power plants burned less of the fossil fuel due to a flood of cleaner electricity, with Beijing continuing to prioritize energy security.
Photo finish
South Africa declared a national disaster after deadly floods across parts of the country. Infrastructure and homes were damaged, schools closed, communities were forced to displace and the iconic Kruger National Park was partly shut.