After a summer of extreme heat, forest fires and flooding in Europe, the costs of climate change – human and financial – have become increasingly high. And a new report from the European Central Bank has reaffirmed the serious consequences of delays or inaction on climate change.
Eurozone banks and businesses risk economic losses and financial instability, the central bank said on Wednesday when it released the results of its first economy-wide climate stress test, as part of ‘a major effort by policy makers to support the transition to a zero carbon world.
By the end of the century, more frequent and severe natural disasters could reduce the region’s economy by 10% if no new climate change mitigation policies are introduced, according to the report. In comparison, the transition costs would not exceed 2% of the gross domestic product.
“The short-term costs of the transition are paltry compared to the costs of unhindered climate change in the medium and long term,” said the report released on Wednesday.
The European Central Bank used data from 2.3 million businesses and 1,600 euro area banks to analyze the impact of three results on the economy. In the first, there is an orderly transition that contains global warming to 1.5 degrees Celsius compared to the pre-industrial era. Then there is a âmessy transition,â in which countries delay action until 2030 and then have to make abrupt and costly policy changes to contain warming to 2 degrees Celsius. The third result, a so-called greenhouse world, no longer involves any action to mitigate climate change and the costs of natural disasters are “extremely high”.
The countries of the European Union have already agreed to reduce their collective greenhouse gas emissions by 55% from 1990 levels by 2030, on the road to carbon neutrality by 2050.
The European Central Bank has made climate change one of its priorities, which will influence monetary policy and financial regulation. But whether central banks should take an active approach to tackling climate change through actions such as changing the mix of asset purchases to exclude oil companies remains a hotly contested topic.
In July, the European Central Bank justified integrating climate change into its monetary policy framework by arguing that âclimate change and the transition to a more sustainable economy affect the prospects for price stabilityâ.
As part of an orderly transition, the average euro area company would have a little more leverage, lower profitability, and higher risk of default over the next four or five years due to the cost of compliance with green policies such as carbon taxes and technology replacement. But then the benefits of the transition would kick in.
By comparison, in a messy transition, the company’s profitability would fall by more than 20% by 2050 and its probability of default would increase by more than 2%. In the greenhouse world where no climate action is taken, profitability would drop by 40% and the probability of default would be 6% higher.
Eurozone banks have similar exposure to transition costs, but their exposure to physical risks varies widely, according to the report. In southern European countries, such as Greece, Portugal and Spain, where the risk of extreme heatwaves and forest fires is higher, climate change is “a major source of systemic risk”, the central bank said.
Forest fires are expected to cause more damage than floods and sea level rise, which will affect northern countries more. For example, in Greece, over 90% of bank loans are classified as being associated with high physical risks due to climate change. In Germany, the share of bank loans is less than 10%.
The European Central Bank intends to use the results of this study to shed light on the climate stress tests it will perform on euro area banks next year.