Climate risks and financial stability: Evidence from the European financial system (2023)

Climate-related risks have become a major concern for financial regulators and can pose a significant threat to financial stability.

In this article, we first propose a theoretical framework for the transmission of climate risks to financial institutions and the financial system.

We then estimate the influence of physical and transition risks on the European financial system through measures of financial stability at the level of banks and across the system.

Our analyses reveal that Scope 3 greenhouse gas emissions, as well as chronic and acute climate risks, negatively affect financial stability both at the level of financial institutions and the system as a whole.

Temperature anomalies, heat waves, wildfires, and droughts are among the most significant risks.

As Europe warms twice as fast as the rest of the world, our theoretical and empirical findings urge regulators to mandate the assessment and disclosure of climate risks by companies in order to enable banks to adjust their capital adequacy requirements.