What does the ECB Climate Stress Test evaluate?

The ECB Climate Stress Test primarily evaluates a bank's exposure to climate risks, which is critical for understanding how external factors related to climate change could impact financial stability. The test assesses how well banks can withstand various climate-related scenarios, examining both physical risks (like damage from extreme weather events) and transition risks (such as the economic impacts of shifting towards a low-carbon economy).

Understanding climate risks is essential for financial institutions because these risks can significantly affect a bank's asset quality, capital adequacy, and overall resilience. By evaluating banks' exposure to these risks, regulators can ensure that financial institutions are prepared to manage potential vulnerabilities associated with climate change, thereby supporting the stability of the financial system as a whole. The focus is not on profitability, customer satisfaction, or interest rates, but rather on how climate-related factors could affect the financial health and risk management of banks.