Why does climate change matter to the ECB?

7 November 2022

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

• the economy, which in turn affects our goal of keeping prices stable;
• the banks that we supervise to keep 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 directly result from climate change, for example when storms or floods damage homes and streets or destroy crops. These events have become more frequent and severe in recent decades and are affecting more and more parts of the economy.

Also, longer-term shifts like changing rain patterns and rising temperatures can disrupt industries and agriculture. Without action to slow these changes down, their effects will only get worse.

What are transition risks?

Cutting carbon emissions is key to slow and avoid the worst 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 services, how we travel and how we feed ourselves. The shift to a greener economy can offer great opportunities, like new jobs and a healthier environment.

But this shift also comes with risks, especially if policies to encourage more sustainable activities are implemented too quickly and companies and people don’t have enough time to adapt. Firms could go out of business, people could lose their jobs and the value of financial assets could fall. This can be caused by new regulation, changing consumer preferences and technological innovations which make environmentally unfriendly products obsolete. These risks are called “transition risks”.

How does climate change affect prices?

Climate change affects the economy, and it therefore also affects prices. Droughts and wildfires can ruin harvests. Floods and low water can disrupt transportation systems and supply chains, at a steep 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 also affect how much things cost. 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 give out loans to their clients, including to companies. If one of those companies gets hit by a flood, it could find itself in financial trouble. It might not be able to pay back its loans – and 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 that are most 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 take care of our own exposure to climate risks. Climate change can have an impact on the assets we hold and the collateral we accept as security when we give out loans to banks. We need to properly manage these risks and 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 are implementing an action plan to incorporate climate change into our monetary policy and have made climate change a key priority in our role as a 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, to be more open about them and to tell us about them in a consistent way. If banks and companies are more aware of climate risks and more transparent about their effects, then everyone can properly take these into account and attach the right price tags. 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.