The EU’s financial regulators announced the release of the results of the “Fit-For-55” climate stress test, examining the resilience of banks, investment funds and the pension and insurance sectors to the transition to a low carbon economy.

The stress test found that while transition risks alone are unlikely to threaten financial stability, the sector could see substantial losses and disruption in some scenarios, leading the regulators to call for “a coordinated policy approach to financing the green transition and the need for financial institutions to integrate climate risks into their risk management in a comprehensive and timely manner.”

The report by Europe’s three primary financial regulatory agencies, the European Supervisory Authorities (ESAs) – which include The European Banking Authority (EBA), The European Insurance and Occupational Pensions Authority (EIOPA), and The European Securities and Markets Authority (ESMA) – follows a request by the European Commission in 2023 for the regulators to carry out a comprehensive system-wide analysis of the financial sector’s resilience to climate-related risks, and its ability to facilitate financing for Europe’s green transition under stress scenarios, with a specific focus on the impact of the EU’s 2030 goal to reduce greenhouse gas emissions by at least 55% by 2030, or its “Fit-For-55” strategy.

The stress test examined 3 scenarios, including a baseline scenario in which the implementation of the “Fit-for-55” package progresses as planned, a “Run on Brown” adverse scenario in which market participants suddenly negatively reassess transition risks in the form of a confidence shock and resulting in a selloff of carbon intensive assets, and a “Run on Brown” scenario amplified by other standard macro-financial stress factors.

The analysis found that the first “Run on Brown” scenario would have only a limited impact on the financial system, with the most significant losses in the investment fund sector at 11.2% of starting point exposures when modelling includes contagion and amplification effects across firms and sub-sectors of the financial system. The adverse scenario coupled with macro stress factors, however, “could disrupt the evolving transition and substantially increase financial institutions’ losses, thereby impairing their financing capacity,” according to the ESAs, with the investment fund sector again seeing the heaviest losses at 25%. According to the ESA’s investment funds suffer the worst losses as they are most exposed to market risk.

Overall, under the most adverse scenarios, the stress test estimated “first-round” losses assessing only individual sector vulnerabilities of approximately €3.9 trillion across the financial system, and additional losses of €1.2 trillion when considering contagion effects across the system.

Click here to access the stress test results.