• European banks face a sharp rise in credit losses by 2045 if climate policies are delayed, with southern Europe at the highest risk.

• A disorderly climate transition could push the cost of risk to 97 basis points, nearly triple the impact of an early policy response.

• Physical climate risks such as rising temperatures and extreme weather pose a greater threat to banks than economic transition risks.

• Banks must integrate climate risk into their strategies and actively engage with clients to mitigate exposure and financial instability.

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Large European banks could see their credit losses triple by 2045 in a worst-case climate scenario, according to new modelling from Scope Ratings.

Banks in southern Europe are expected to be the hardest hit as climate-related financial risks escalate.

Scope’s analysis, which utilized three climate models developed by the Network of Central Banks and Supervisors for Greening the Financial System, predicts a significant rise in banks’ cost of risk if climate policies are delayed.

In a ‘disorderly’ transition scenario, where climate policies are implemented late, the cost of risk could soar to 97 basis points by 2045-50. This is a stark contrast to a scenario where policies are introduced early, keeping the cost of risk at 34 basis points.

Pauline Lambert, executive director for financial institutions at Scope Ratings, emphasized the urgency of proactive climate risk management. “Banks need to have credible climate risk management strategies in place and proactively engage with their clients to manage the risk in this area,” she told Scope-hosted webinar.

The findings are based on a synthetic bank profile reflecting the geographic and sectoral credit exposures of European banks with total assets exceeding €500 billion, drawn from 73 lenders participating in the European Banking Authority’s 2023 transparency exercise.

The results indicate that banks in southern Europe are particularly vulnerable to climate risks, followed by those in eastern Europe.

The heightened exposure in southern and southeastern Europe is attributed to the region’s warmer climate, which makes these economies more susceptible to climate change-related GDP shocks and higher credit losses.

Regionally, median annual additional credit losses for 2045-50 vary significantly. Northern European banks are projected to face a relatively mild impact of up to six basis points, while western and eastern European banks could see losses of 27 and 24 basis points, respectively.

Southern European banks, however, are set to suffer the most, with median losses reaching 94 basis points and some institutions facing losses exceeding 250 basis points.

Climate-induced economic shocks could push portfolio returns into negative territory for 21 banks under the disorderly scenario and 19 banks under a ‘hot house’ scenario, where no new climate policies are introduced beyond existing regulations.

The study highlights that physical climate risks—such as rising temperatures, sea level increases, floods, and wildfires—pose a much greater threat to banks’ financial stability than transition risks linked to the economic shift toward a low-carbon economy.

This underlines the pressing need for financial institutions to bolster resilience against environmental disruptions and integrate climate risk considerations into their long-term strategies.