Climate effect on banks Without having to cover triple losses

Heavy rain and storms arriving on bank balance sheets, with the possibility of storms. If the destruction of nature and ecosystems has an enormous environmental cost, the financial burdens appear equally heavy. Not only for the State, often called to intervene, and for the insurance sector, which in this very phase is faced with the obligation of catastrophe policies for companies, but also for the credit sector. Think of the damage caused by a flood or landslide to homes purchased by families with a mortgage or, again, to the production site of a company indebted to the banks.

A new alarm bell has been sounded by the ECB, which in the latest economic bulletin focused attention on the financial risks resulting from the degradation of nature and the loss of biodiversity. In general, we read in the analysis, “the materialisation of both physical and transition risks can lead to losses capable of threatening financial stability”. Just to cite an example, soil erosion and the loss of pollinators such as bees and butterflies «compromise agricultural productivity and push up food prices, while reducing the value of land and the income of people farmers.”

Not only that. Out of 4.2 million non-financial companies in the euro area, the ECB calculates that 72% “would suffer significant economic repercussions” from the degradation of ecosystems. The fact, the study highlights, is that “vegetation cover reduces soil erosion, prevents avalanches and landslides, and provides protection from floods and storms.” From the banks’ point of view, approximately 75% of the financed companies depend «heavily on at least one ecosystem service. If environmental degradation continues to follow current trends – it is added – loan portfolios could be significantly affected”. The Italian MPS, in the latest half-yearly report, provides some important clues about the vulnerability of institutions to acute physical risk, mainly landslides and floods, and to seismic risk. The state-owned bank reports that, as of June 30, “20% of loans to non-financial companies (40.47 billion in total) are exposed to high or very high physical risk (acute or chronic”). It drops to 16.9% if you look at residential mortgages. Seismic risk has a greater impact: between medium and high, it weighs 34.1% on loans to companies and 29.1% on mortgages to families.

The ECB comes to the conclusion that, if «the current trend in emissions continued at a global level and significant pressure continued to be exerted on biodiversity», euro area banks would record «losses on average almost three times higher than those envisaged in a future scenario of efficient use of resources, in line with the Paris Agreement”. The greatest damage would occur in Germany, “given the degree of dependence of the country’s strongest economic sectors, such as the manufacturing sector, on biodiversity levels”.

According to Mario Noera, professor at Bocconi University and senior associate of the Ecco think tank, «climate risks are also financial risks and can become immediate», which is why «banks must take them into account today, adjusting capital and in general taking precautions. In sector jargon, two terms are used. By single materiality we mean the damage that can arise from the climate and the environment towards a specific institution. The European Green Deal legislation instead embraces dual materiality, so the effects that individual institutions produce on the environment must also be taken into account.”

In this regard, in the same study, the ECB states that European non-financial companies, through land conversion and greenhouse gas emissions, generate a local impact equivalent to the loss of approximately 365 million hectares of natural habitat in the area alone. ‘euro. The loans are also highly concentrated, to the point that ten banks “are responsible for financing around 40% of the estimated global biodiversity loss caused by euro area businesses”.

Hence Frankfurt’s invitation to “understand how banks and the financial system are exposed to the amplification of climate-related risks due to the degradation of ecosystem services”. In other words, the more you finance organizations that pay little attention to the environment, the less incentive they will have to correct their efforts, contributing to fueling extreme climate events with all their dramatic consequences.

«Even if the ECB – comments Noera – were to accept the principle of double materiality, it would mean that the monetary and supervisory policy of the euro area, equipped with very powerful tools, could direct credit to favor the energy transition. For example, higher capital ratios could be required from banks that are highly exposed in terms of financing in polluting sectors and vice versa. Financial institutions are also active agents in generating correct behavior, so they can play a central role by accelerating mitigation investments, protecting the economy and also defending themselves.”

On the possibility of providing rules based on the environmental impact of credit institutions, in recent days, the Minister of Economy, Giancarlo Giorgetti, urged caution. «The situation – he declared – risks becoming complex if we ask the banking system to submit not only to prudential purposes but also to systemic interests, as happens with the progressive pervasiveness of ESG parameters», i.e. aimed at the environment, social and good governance. For Noera, «the concern is right, as the transition involves risks and costs and can be destabilizing if not governed with a long-term vision. But the policy of delay is dangerous, because climate damage is unleashed anyway and over time becomes much greater than the investments currently needed to avoid it.”

A similar concept was expressed by the president of the ECB, Christine Lagarde, following the “stress tests” on the climate completed a year ago and conducted on credit institutions. Postponing investments for the energy transition “risks increasing the bill we will end up paying. In our stress test on the climate – Lagarde explained – we demonstrated that, in the event of a late transition, the most vulnerable banks would face losses on their loan portfolios twice as high as the median». In short, time is money, in the sense that by prevaricating about the climate and the environment you risk greater losses.