- CLIMATE-RELATED INDICATORS
Analytical indicators on physical risks
Global warming increases the likelihood of extreme weather events. The resulting damage can have a significant impact on the financial system. For example, companies affected by flooding or droughts might find it difficult to service their debts. Or collateral, such as buildings or land, might suddenly lose value. This can affect price levels and ultimately the stability of our financial system.
Our physical risk indicators take into account risks stemming from climate change-induced natural hazards, like floods, storms or wildfires, that can affect the performance of loans, bonds and equities.
They cover seven natural hazards: coastal flooding, river flooding, wildfires, landslides, subsidence, windstorms, water stress.
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Because compiling these indicators is subject to various statistical and data-related limitations, including limited data coverage over time and across regions, they are only being released as analytical indicators for the time being. Shortcomings relate to, for example, accuracy in identifying the location and vulnerability of exposed debtor activities or paucity of information on risk mitigation measures.
For further details on the methodology, data sources and limitations please consult the methodology report and the technical annex.
Potential exposure at risk
The potential exposure at risk indicator provides information on the share of financial institutions’ portfolios exposed to non-financial corporations located in areas susceptible to specific physical risks such as floods or storms. This indicator incorporates all risk exposures, regardless of the intensity or likelihood of the hazard occurring. It gives an indication of the potential total amount exposed to certain hazards – in other words, the full amount of loans, bonds and equity that could be exposed to physical risks. This provides insight into how widespread the hazard’s effects could be within the financial system.
The highest potential exposures at risk are associated with water stress, wildfires, subsidence and windstorms. These hazards are more prevalent, as they are not limited to specific geographical regions such as river, coastal or mountain areas.
Potential exposure at risk by hazard type
Risk scores complement the potential exposure at risk indicator by sorting exposures according to risk level categories and indicating the percentage of the portfolio that is associated with a specific risk score from 0 (no risk) to 3 (high risk). The scores for corporate groups are calculated using simple averages across the parent company and its subsidiaries.
In contrast to potential exposure at risk, the probability of the event occurring is taken into account in risk scores. The scores do not, however, provide information on the size of expected financial losses.
For most of the hazards assessed, a very large share of the potential risk exposure is allocated to the lowest risk category. But for water stress or subsidence, medium and high-risk scores have a larger share than for the other hazards analysed. And windstorm risks are estimated to be low for the entire exposure at risk, owing to relatively low hazard intensity and the solidity of buildings and construction materials used in the euro area.
Please note that comparing the rankings of different hazards is not advisable because they are based on differing methodological assumptions.
Hazard-specific risk scores
Normalised exposure at risk
Normalised exposure at risk provides a measure of the level at which institutions’ portfolios are at risk via their loans, debt and equity exposures to non-financial corporations located in areas susceptible to specific physical risks. The normalised exposure to risk indicator takes into account the intensity of a hazard. For example, for a flood that is one metre deep, damage amounting to 25% of a company’s fixed assets is assumed, while for a flood that is over three metres deep it is assumed that the company’s total fixed assets are destroyed. In addition to the intensity of a hazard, the probability of a hazard occurring is also included in the calculations for normalised exposure at risk. On this basis, it is possible to estimate expected annual losses.
Normalised exposure at risk indicators combine expected annual losses and financial exposure that companies have with financial institutions set them into relation to the company’s revenues or total assets. Normalised exposure at risk represents an annual amount of financial exposure at risk arising from one of three hazard types: windstorms, coastal flooding or river flooding. This indicator can be used for comparative risk assessments, for example across hazard types and countries.
Chart 3 shows normalised exposure at risk for three different hazards broken down into economic sectors. The distribution across sectors broadly reflects the share of each sector in terms of total financial assets, with the highest share of services at around 67%. However, when compared with other sectors, the energy sector is proportionally more exposed to floods. Given that normalised exposure at risk captures material damages, this result may reflect energy companies having relatively high levels of fixed assets, such as pipe networks, cables and power sources like turbines or solar panels, and many energy companies needing to maintain assets near to water sources.
Please note that the indicators do not take into account physical protection measures that already exist, such as dikes. Nor do they take into account financial hedging, such as insurance of assets. These mitigation measures can significantly reduce the damage caused by the hazard and/or subsequent losses. In addition, the physical locations of a company’s assets are not always known and allocated to headquarters locations, which can lead to mismeasurement of risk.
Normalised exposure at risk by sector
The underlying aggregated data for the analytical physical risk indicators are available as compressed csv files below.
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