Elderson: Climate, nature risks demand central bank action
Frank Elderson, Member of the Executive Board of the ECB and Vice-Chair of the Supervisory Board, highlighted the growing material risks from climate change and nature degradation for the EU economy and financial system. Speaking at the University of Oxford, he outlined how these risks impact price stability, financial institutions, and central bank balance sheets.
The dual threat to price stability
Climate change already poses significant material risks to the EU economy, with direct losses to infrastructure and assets estimated at EUR 822 billion between 1980 and 2024.
These losses are expected to increase, as exemplified by severe floods in Slovenia (2023) and Valencia (2024) causing damages equivalent to 16% and 20% of regional GDP, respectively.
Elderson also addressed "fossilflation," noting that Europe's energy dependence is a critical vulnerability that risks price stability.
The energy crisis following Russia's invasion of Ukraine pushed euro area inflation to 10.6% in October 2022, emphasizing the urgent need for a transition to renewable energy sources to achieve energy security and affordability.
Climate change affects price stability through macroeconomic indicators and monetary policy transmission, and impacts the value and risk profile of assets on the Eurosystem's balance sheet.
Nature's hidden dependencies
Elderson expanded the scope to nature-related risks, defining nature as consisting of multiple dimensions like water availability and biodiversity, which provide numerous ecosystem services.
He stressed the strong interconnection between nature degradation and climate change, where degradation can amplify climate change, and healthy nature is essential for limiting it.
Observed nature-related economic shocks include global harvest shocks contributing to 30% of medium-term euro area inflation volatility, and soil erosion causing €1.25 billion in annual agricultural productivity losses in the EU.
Approximately 3 million out of 4.2 million companies in the euro area are highly dependent on ecosystem services, with 75% of banks' corporate loans (€3.1 trillion) extended to these highly dependent borrowers.
Water-related ecosystems pose the highest risk, with a 1-in-100 year drought potentially putting 24% of euro area economic output and 19% of bank loans at risk due to surface water scarcity.
Supervision meets litigation
The ECB has implemented a multi-year program to strengthen banks' capacities in managing climate and environmental risks, including a guide, thematic review, and stress tests.
While significant strides have been made, weaknesses persist in the comprehensiveness and granularity of risk assessment and modeling.
Furthermore, climate and nature litigation is a growing risk for the financial system, with cases against states, corporates, and financial institutions increasing globally.
The speech effectively broadens the central bank's focus from climate to nature, highlighting critical interdependencies.
While acknowledging progress in banking supervision, the increasing threat of climate and nature litigation underscores the urgency for more robust risk management.
The call for continued action is clear, but the practical implementation challenges for financial institutions remain substantial.