Economic Impact of Climate Change in Europe Is Scrutinized

After a summer of extreme heat, wildfires and floods in Europe, the costs of climate change — human and financial — have become increasingly stark. And a new report by the European Central Bank has reaffirmed the severe consequences of delays or inaction on climate change.

Banks and companies in the eurozone risk economic loss and financial instability, the central bank said Wednesday as it published the results of its first economywide climate stress test, part of a major effort by policymakers to support the transition to a net-zero carbon world.

By the end of the century, more frequent and severe natural disasters could shrink the region’s economy by 10 percent if no new policies to mitigate climate change are introduced, the report said. By comparison, the costs of transition would be no more than 2 percent of gross domestic product.

“The short-term costs of transition pale in comparison with the costs of unfettered climate change in the medium to long term,” the report published on Wednesday said.

The European Central Bank used data from 2.3 million companies and 1,600 banks in the eurozone to analyze the impact of three scenarios on the economy. In the first, there is an orderly transition that contains global warming to 1.5 degrees Celsius compared with the preindustrial era. Then there is a “disorderly transition,” in which countries delay taking action until 2030 and then have to make abrupt and costly policy changes to contain warming to 2 degrees Celsius. The third scenario, a so-called hot house world, involves no more actions to mitigate climate change and the costs from natural catastrophes are “extremely high.”

European Union countries have already agreed to cut their collective greenhouse gas emissions by 55 percent from 1990 levels by 2030, on a path to be carbon neutral by 2050.

The European Central Bank has made climate change one of its central focuses, which will influence monetary policy and financial regulation. But it is still a hotly contested subject whether central banks should take an active approach to tackle climate change through actions such as changing the composition of asset purchases to exclude oil companies.

In July, the European Central Bank justified incorporating climate change into its monetary policy framework by arguing that “climate change and the transition towards a more sustainable economy affect the outlook for price stability.”

Under the orderly transition scenario, the average eurozone company would have slightly more leverage, less profitability and higher risk of default over the next four or five years because of the cost of complying with green policies such as carbon taxes and replacing technologies. But then the benefits of the transition kick in.

By comparison, in a disorderly transition, the company’s profitability would drop by more than 20 percent by 2050 and its probability of default would rise by more than 2 percent. In the hot house world where no climate actions are taken, profitability would slump 40 percent and probability of default would be 6 percent higher.

Banks across the eurozone have a similar exposure to the costs of transition but their exposure to physical risks vary greatly, the report said. In countries in southern Europe, such as Greece, Portugal and Spain, where there is a higher risk of extreme heat waves and wildfires, climate change represents “a major source of systemic risk,” the central bank said.

Wildfires are expected to create more damage than floods and rising sea levels, which will affect northern countries more. For example, in Greece, more than 90 percent of bank loans are classified as being associated with high physical risks from climate change. In Germany, the share of bank loans is less than 10 percent.

The European Central Bank intends to use the results of this study to inform the climate stress tests it will do on eurozone banks next year.