Integrating climate risk into the 2025 EU-wide stress test: the effects of climate risks for firms

As authorities across the euro area work towards including climate risks into regular stress-testing frameworks, this article offers a starting point for assessing bank resilience to climate risks that materialise under a short-term horizon. This is relevant since acute physical risks and abrupt policy changes can also materialise at short notice and affect the balance sheet of financial institutions. The analysis uses an adverse macroeconomic backdrop that combines the EBA’s adverse scenario with the Network for Greening the Financial System’s Nationally Determined Contributions (NGFS NDCs) scenarios. It extends the EU-wide 2025 stress test results by incorporating both transition and acute physical climate risks into the credit risk assessment for non-financial corporations by means of top-down models. Transition risks driven by green investments to reduce emissions amplify credit losses and reduce banks’ CET1 capital, particularly in high energy-intensive sectors. Similarly, acute physical risks such as extreme flood events reduce CET1 capital through direct damage, local disruptions and macroeconomic spillovers. While the magnitude of impacts varies across banks, the analysis shows that both types of climate risk can have a moderate but consequential effect on capital ratios. Notably, the banks most exposed to climate-related losses may differ from those identified as the most vulnerable in the broader EU-wide assessment. These findings underscore the importance of incorporating both types of climate risk into regular financial stability assessments. JEL Classification: G20, G28