Why does climate change matter to the ECB?

Climate change matters to us at the ECB because it affects:

• the economy, and in turn our goal of keeping prices stable;
• the banks we supervise and our role in keeping them safe and sound;
• our own exposure to risk.

Climate change brings about two types of risks for our economy: physical and transition risks.

What are physical risks?

Physical risks are risks that arise from the changes in weather and climate that impact economies. For example, storms or floods can damage homes and streets or destroy crops. Because of climate change, such events have become more frequent and severe in recent decades and their economic impact is growing.

Longer-term shifts, like changing rainfall patterns and rising temperatures, can also disrupt industries and agriculture. Without action to slow these changes down, their effects will only worsen.

What are transition risks?

Cutting carbon emissions is key to slowing and avoiding the worst effects of climate change. This is why the EU has committed to a net-zero economy by 2050. To reach this goal, we need to make all our economic activities greener, including how we produce goods and provide services, how we travel and how we feed ourselves. The shift to a greener economy can offer significant opportunities, like new jobs and a healthier environment.

But this shift also comes with risks, particularly if policies that encourage more sustainable activities are implemented too quickly, and companies and people do not have enough time to adapt. Firms could go out of business, people could lose their jobs and the value of financial assets could fall. These developments can be caused by new regulations, changing consumer preferences and technological innovations which make environmentally unfriendly products obsolete. They are known as “transition risks”.

How does climate change affect prices?

Climate change affects the economy and therefore also affects prices. For example, droughts and wildfires can ruin harvests, while floods and low water levels can disrupt transportation systems and supply chains, at a high cost to companies. Such events can also have knock-on effects on financial markets and instability can spread as a result. All of this can have an impact on prices and therefore on our ability to keep them stable.

Policies to encourage greener activities can also affect how much things cost. For instance, subsidies for green energy investments or taxes on coal, oil and gas can have an impact on the economy and prices.

How does climate change affect the banks we supervise?

One of the main tasks of a bank is to provide loans to its clients, including companies. If one of those companies is hit by a flood, it could find itself in financial trouble and might not be able to pay back its loans. This would also have a negative effect on the bank.

This is why we must make sure that banks are aware of their climate-related risks, such as high exposure to carbon-intensive sectors or clients located in areas likely to be affected by climate change. We ask banks to take these risks into account in their strategy, governance and risk management.

How does climate change affect our balance sheet?

We also need to consider our own exposure to climate-related risks. Climate change can affect the assets we hold and the collateral we accept as security when we lend to banks. We therefore need to manage these risks properly and work to reduce them.

We are not the main actors in the shift to a greener economy. Governments and parliaments are in the lead, but we are committed to playing our part in the fight against climate change, within our mandate.

We take into account the implications of climate change as well as nature degradation for our monetary policy and have made these climate and nature -related risks a key priority in our role as a banking supervisor. We are improving our models , the quality of the data we use and the way we manage our own risks.

We want to foster wider changes in behaviour. Our rules can encourage banks to be more aware of climate risks related to the assets they hold and to disclose these risks consistently and openly. If banks and companies are more aware of climate-related risks and more transparent about their effects, everyone can properly take these into account when pricing assets. We are also sharing our expertise and the lessons we have learnt to encourage others to do their part in the fight against climate change.