Accounting for climate transition risk in banks’ capital requirements

Lucia Alessi, Erica Francesca Di Girolamo, Andrea Pagano and Marco Petracco Giudici

Journal of Financial Stability, 2024, vol. 73, issue C

Abstract: This paper uses a stylized simulation model to assess the potential impact of climate transition risk on banks’ balance sheets in a climate-stress-testing (i.e. short-run) framework. We show that a moderate to high transition risk increases overall bank losses only relatively modestly if the baseline is a stressed macroeconomic scenario. However, even in a benign macroeconomic scenario, if high-carbon assets are at least 13% riskier than comparable assets a fire sale mechanism could amplify an initially contained shock into a systemic crisis, resulting in significant losses for the EU banking sector. We show that transition risks are concentrated, and find that an additional capital buffer of 0.9% risk-weighted assets on average would be sufficient to protect the system.

Keywords: Climate transition risk; Climate stress-testing; Dynamic balance sheet; Banking crisis (search for similar items in EconPapers)
JEL-codes: C15 G2 Q54 (search for similar items in EconPapers)
Date: 2024
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Working Paper: Accounting for climate transition risk in banks' capital requirements (2022)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finsta:v:73:y:2024:i:c:s1572308924000548

DOI: 10.1016/j.jfs.2024.101269

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