Central Bank Governor: Need to accelerate efforts to deal with climate change

Cyprus’ Central Bank Governor Constantinos Herodotou has stressed the need for all stakeholders, to accelerate efforts to deal with the consequences of climate change and added that in 2022 climate stress tests for the banks directly supervised by the ECB will be carried out.

Addressing the 12th Limassol Economic Forum, on Friday, Herodotou said that US analysis shows that unless there are immediate and large-scale reductions in greenhouse gas emissions limiting global warming by 1.5 or 2 degrees Celsius as per the target of the Paris Agreement will be beyond reach.

“This is not an exaggeration,” he noted.

“The Mediterranean region is even more susceptible to climate change; It is warming 20% faster than the global average, exerting additional pressure on already strained ecosystems and vulnerable economies,” the Central Bank Governor said.

As he noted, a 2 degree global warming will reduce precipitation by 10% - 15%, an increase of 2 - 4 degrees will reduce precipitation by up to 20% in southern Europe. This, he pointed out, “would cause water demand to double or even treble by 2050.”

Herodotou referred to a scenario analysis by the ECB which concluded, among other things, that the economic costs of climate change are substantially larger in the absence of timely adaptation and climate mitigation.

Referring to the different scenarios, he said the orderly transition scenario assumes early and effectively implemented policies to meet the Paris Agreement targets, the disorderly transition scenario assumes a delay, while the "hot house" scenario assumes that there are no new policies.

Until 2050 the hot house and disorderly transition scenarios are more or less equally detrimental compared to the orderly transition scenario, but from 2050 the projected GDP loss under the hot house scenario accelerates dramatically every year, he warned.

The GDP, he pointed out, ends up being double compared to disorderly, while the orderly transition sees a zero change.

According to Commission estimates, the Central Bank Governor said, for “emission reduction targets by 2030, namely by 55% compared to 1990, annual green investment would need to increase by around 350 billion euros per year for the next ten years compared to the previous decade.” It is clear that the scale of investment challenge is not the same across sectors or countries. 

The participation of the private sector is key, he stressed

At the same time, he said that the EU is taking steps through the introduction of initiatives that among others, will force sustainability disclosures and enable the better pricing of climate related risks, foster and leverage technological innovation.

Herodotou also pointed out that the “green and digital agendas are to a large extent interconnected.”

As regulators, he noted “we are worried that banks are currently not prepared for the risks both financial and non – financial” that could arise both in terms of the direct physical risks that is to say the economic impact from the national disasters that will affect asset prices such as real estate prices and the transition risks that is to say the costs that will come from the policies to transition to a low carbon economy which again will impact asset prices.

He announced that in 2022 a supervisory climate stress test for the banks directly supervised by the ECB will be conducted.

Outlining the different scenarios, Herodotou said that as the adverse scenario materializes the probabilities for default for euro corporate firms are set to rise up to 7% on average by 2050 compared with the orderly transition scenario and profitability is set to decrease by almost 40% in the most vulnerable jurisdictions.

By 2050 on the basis of the adverse scenario the average loan portfolio is 7% more likely to default than under an orderly transition. The respective probability for the most exposed banks would increase more than 4 times by 2050, namely 30%, he said.

He spoke of an “urgent need for banks in Southern European countries especially to urgently develop the mechanisms necessary to better account for physical risks.” 

“Ensuring success requires that the green and digital agendas are as connected as possible and supported by all stakeholders,” Herodotou stressed.

We need, he noted, “to accelerate our efforts as scenario analysis shows that the economic and social consequences of climate change will be profound and substantially larger in the absence of timely and effective adaption and mitigation strategies.”

Stakeholders, he added, “should be cognizant of their starting point in order to set the appropriate degree of ambition and detail in their plans.”