RiskSeptember 22, 2023

European Central Bank Warns Green Transition Needs to Quicken

The bank’s second climate stress test showed ‘there is a clear need for speed’ to meet the goals of the Paris agreement.

Reported by Michael Katz

If the pace of the transition to a low-carbon economy in the eurozone does not accelerate soon, the financial vulnerability of companies and households will, the European Central Bank warned in a report detailing the results of its second economy-wide climate stress test.

The stress test studied the potential vulnerabilities of the eurozone economy and financial system in a set of three transition scenarios toward a net-zero emissions economy: an “accelerated transition,” a “late-push transition” and a “delayed transition.”

The accelerated transition frontloaded green policies and investment, leading to a reduction in emissions by 2030 in line with the goals of the Paris Agreement. The late-push transition continued on the current path and did not accelerate until 2026; however, it was enough to meet Paris-aligned emission reductions by 2030. The delayed transition started in 2026 and was not sufficient to reach Paris Agreement goals by 2030.

According to the ECB, the results of the latest test show that the best way to achieve a net-zero economy is for companies, households and banks in the eurozone to accelerate the green transition.

“We need more decisive policies to ensure a speedier transition towards a net-zero economy in line with the goals of the Paris Agreement,” ECB Vice President Luis de Guindos said in a release. “Moving at the current pace will push up risks and costs for the economy and financial system. There is a clear need for speed on the road to Paris.”

The ECB also noted that its findings align with those of other organizations’ climate stress tests; the Financial Stability Board and the Network for Greening the Financial System have already completed 35 exercises on climate scenario analysis. The report stated that for abrupt transition scenarios in particular, the other exercises have also found that “climate-related risks would be concentrated within sectors, giving rise to large tail risk.”

Although an accelerated transition would initially involve greater investment and higher energy costs, according to the report, the financial risks would decrease significantly in the medium term. Profits and purchasing power would be less negatively affected because the frontloaded investment in renewable energy would pay off earlier and ultimately reduce energy expenses. The ECB stated that in the accelerated transition, green investment by eurozone firms would rise to 2 trillion euros ($2.14 trillion) by 2025, but in the other two scenarios, that figure amounts to only 500 billion euros.

“The earlier the transition happens, the smaller the financial risk, and consequently the less policy support is required to mitigate the costs,” the report said. “Assuming a specific target for emissions’ reduction by 2030, an accelerated transition is preferable to a late-push transition, which would be more sudden and disruptive.”