How to strengthen climate risk management and supervision to protect financial stability
Climate change does not conform to business, political or supervisory regime cycles– its adverse long-term impacts lie beyond such horizons. Ten years ago, when Mark Carney highlighted this paradox in his landmark Tragedy of the Horizons speech, climate change was not considered a financial stability risk. Today, European supervisory stress tests estimate up to €638 billion in banking losses over 8 years, while the European Central Bank (ECB) reveals that over 90% of eurozone banks face climate and environmental risks. A key question arises: Is the supervisors’ primary focus on greening the financial system sufficient in the face of rising risks, especially stranded assets?
I4CE’s analysis on stranded assets recommends three changes to manage these underestimated risks effectively.
Banks should proactively manage assets at risk of stranding by providing credible financing to facilitate an orderly transition in the real economy, including through sectors like cleantech. They should also integrate stranding risks into their transition risk frameworks to evaluate their clients’ transition preparedness. Finally, supervisors must leverage their prudential toolkit to limit the buildup of climate risks and catalyse transition finance. Dynamic macroprudential buffers would help absorb stranding losses, while prudential transition plans would help monitor banking credit flows toward transition opportunities. The European Banking Authority’s (EBA) 2025 guidelines expect banks to proactively engage their clients through ‘structured transition planning’.
As the European Union simplifies sustainability rules, the limited availability of granular data could impact the effectiveness of supervisory tools, creating blind spots for monitoring disorderly transition risks. Crucially, supervisors must not only reinforce their monitoring tools but also encourage banks to finance transition needs – preventing the buildup of risks in the real economy and protecting financial stability.
