Turned into a “credit risk”… Heat waves threaten European banks | economy

European supervisory authorities are moving to expand their oversight of banks’ exposure to heatwave risks, with the acceleration of economic losses resulting from extreme climate phenomena on the fastest-warming continent in the world, and the transformation of heat from a health and environmental issue into a credit risk that may affect loans, insurance, and asset quality.

According to Bloomberg, citing a spokesman for the European Banking Authority, the authority is working to develop tools to measure the financial impact of extreme heat, which may open the door to later including heat waves as an independent category in periodic stress tests that measure the ability of banks to withstand losses.

Climatic stress tests

The step comes as the European Banking Authority prepares for a broad stress test in 2027 that incorporates climate risks into its methodology, with the participation of 63 banks from the European Union and Norway, including 47 banks from the euro zone, covering about 75% of the European banking sector.

The authority says that European stress tests are carried out in cooperation with the European Systemic Risk Board, the European Central Bank and the European Commission, with the aim of assessing the banks’ ability to confront possible negative developments in the markets and the economy.

The European Environment Agency estimated the economic losses resulting from weather and climate-related phenomena in the European Union at about 822 billion euros. ($938 billion) Between 1980 and 2024, including more than 208 billion euros ($237 billion) between 2021 and 2024.

Agency data show that the last four years were all among the top 5 years in terms of annual losses since 1980.

Data from the European Environment Agency show that floods accounted for 47% of the total climatic and weather losses in the European Union between 1980 and 2024, while heat waves alone caused about 18% of the total, indicating that heat is no longer an indirect or limited threat.

Average annual losses also rose to 44.9 billion euros($51.3 billion) In the period between 2020 and 2024, compared to about 8.6 billion euros in the 1980s ($9.8 billion).

Difficulty in measuring

However, heat remains more difficult to measure than floods and fires, because its impact does not appear only in the damage to physical assets, but also extends to labor productivity, the performance of economic sectors, energy demand, agricultural production, and broader economic activity.

Therefore, the upcoming stress test will focus on flood risk, where risk maps can be linked to the locations of real estate assets and collateral, allowing for a more consistent loss estimate across banks.

The European Environment Agency says that Europe is the fastest warming continent in the world, and that climate risks threaten energy and food security, infrastructure, water resources, financial stability and population health. Copernicus data also indicates that Europe has been warming since the 1980s at a rate nearly twice the global average.

The European Environment Agency’s heat risk map shows that the number of hot days and tropical nights is likely to increase significantly across Europe, and that 46% of hospitals and 43% of schools in European cities are located in areas at least two degrees Celsius hotter than the regional average, reflecting the vulnerability of urban structures to heat waves.

Climate risk and credit decision

For banks, heat waves may lead to a decline in the productivity of borrowing companies, an increase in the cost of energy and insurance, a decrease in the value of some real estate guarantees, and an increase in the probability of default in sectors such as agriculture, construction, tourism and transportation. Uninsured losses can also put pressure on the budgets of companies and families, especially since the European Environment Agency estimates that less than 20% of climate and weather losses in the European Union between 1980 and 2024 were insured by the private sector.

According to Bloomberg, some banks have begun amending their credit policies based on customers’ physical exposure to climate change, and the risk framework of the Spanish Bank BBVA shows that the bank integrates climate risks as a source of financial risk within portfolio management, customer review, and financing granting processes, which reflects the file’s transition from voluntary disclosure to the core of credit decisions.

European Central Bank Executive Board member Frank Elderson said in a speech this month that low-emitting companies, and those that have credible transition plans to reduce emissions, benefit from better lending conditions compared to higher-emitting companies that do not have convincing transition plans.

The monitoring move coincides with a broader political debate within the European Union regarding protecting the population from heat waves and fires. The European Parliament is scheduled to discuss tomorrow, Wednesday, the Union’s response and its readiness to protect citizens from recurring heat waves and upcoming forest fires, after the escalation of climate disasters prompted the expansion of European response tools and financing.