EU banking supervisor The European Banking Authority (EBA) announced the draft methodology and templates for the 2027 EU-wide stress test, which include the incorporation of climate risks for the first time.
In the initial stage, the EBA said that climate risks will be assessed through a dedicated module and will not affect the core stress test results, although the banking supervisor said that the introduction of climate risks in the stress testing framework marks “an important step towards embedding climate considerations into prudential supervision.”
The development of stress testing methodology forms part of the EBA’s role to coordinate EU-wide stress tests to assess the resilience of financial institutions to adverse market developments. The EU-wide stress test is designed to provide supervisors, banks and other market participants with a common analytical framework to consistently compare and assess the resilience of EU banks and the EU banking system to shocks, and to challenge the capital position of EU banks. The EBA, along with the other EU financial regulatory agencies recently published guidelines on the integration of ESG factors, starting with climate and environmental risks, into supervisory stress tests for banks and insurance companies.
The EBA new climate module evaluates the impact of selected transition and physical risk shocks that may materialize, with institutions required to apply climate transition and flood scenarios together with the adverse macro financial scenario of the 2027 EU-wide stress test, over a 3-year horizon.
Transition risks scenarios envision a sudden stringent shift in climate policy, which triggers rapid capital allocation and severe real-economy impacts. Transition risk shocks in the module include carbon pricing, country GHG emissions pathways, and energy price shocks triggered by higher carbon prices, as well as GVA (gross value added) shocks to capture sector specific impacts of transition risk on economic activity.
The stress test’s physical risk scenario focuses on potential financial and economic damage caused by riverine flood events occurring simultaneously within EEA Member States.
The stress test’s climate module focuses on institutions’ exposure to non-financial corporations and to real estate, which the EBA said reflects the materiality of these areas with respect to transition and flood risk transmission channels.
The introduction of the new climate module forms part of a series of changes by the EBA to the stress test, which also includes a significant simplification, with a 55% reduction in data points. The EBA said that it is launching a consultation on the new stress test methodology, with participation from 63 banks, covering 75% of the EU banking sector.
Click here to access the draft methodology and templates.
