After a summer of extreme heat, forest fires and floods in Europe, the costs of climate change – human and financial – have increased. And a new report from the European Central Bank has reaffirmed the dire consequences of climate change delays or inaction.
Eurozone banks and businesses risk economic loss and financial instability, the central bank said on Wednesday as it released the results of its report. first economy-wide climate stress test, part of a major effort by policymakers to support the transition to a zero-carbon world.
By the end of the century, more frequent and severe natural disasters could shrink the region’s economy by 10 percent if new policies to mitigate climate change are not put in place, the report said. By way of comparison: the transition costs amount to a maximum of 2 percent of the gross domestic product.
“The short-term costs of transition pale in comparison to the medium- to long-term costs of rampant climate change,” the report published Wednesday said.
The European Central Bank used data from 2.3 million companies and 1,600 banks in the eurozone to analyze the impact of three outcomes on the economy. In the first, there is an orderly transition that includes global warming to 1.5 degrees Celsius compared to the pre-industrial era. Then there’s a ‘disorderly transition’, where countries delay taking 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, no longer involves actions 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 percent by 2030 from 1990 levels, on their way to being carbon neutral by 2050.
The European Central Bank has made climate change one of its central concerns, which will affect monetary policy and financial regulation. But it is still a hotly contested topic whether central banks should take an active approach to tackling climate change through actions such as changing the composition of asset purchases to exclude oil companies.
In July, the European Central Bank justified the inclusion of climate change in its monetary policy framework by stating that “climate change and the transition to a more sustainable economy affect the prospects for price stability”.
On an orderly transition path, the average eurozone company would have slightly more leverage, less profitability and a higher risk of default over the next four or five years due to the costs of complying with green policies such as carbon taxes and replacing technologies. But then the benefits of the transition would kick in.
By comparison, in a disorderly transition, the company’s profitability would fall by more than 20 percent by 2050 and the probability of default would increase by more than 2 percent. In the greenhouse world where no climate action is taken, profitability would fall by 40 percent and the probability of default would be 6 percent higher.
Banks across the eurozone have similar exposure to transition costs, but their exposure to physical risks varies widely, the report said. In countries in southern Europe, such as Greece, Portugal and Spain, where the risk of extreme heat waves and wildfires is higher, climate change is “a major source of systemic risk,” the central bank said.
Wildfires are expected to cause more damage than floods and rising sea levels, which will affect northern countries more. In Greece, for example, more than 90 percent of bank loans are classified as associated with high physical risks from climate change. In Germany, the share of bank loans is less than 10 percent.
The European Central Bank plans to use the results of this survey to inform the climate stress tests it will conduct on eurozone banks next year.