Banks’ Exposure to Heat-Related Losses Faces Scrutiny in EU

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(Bloomberg) — Europe’s bank watchdog will look at how exposed lenders are to heat-related risks, as temperature records keep getting broken.

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The European Banking Authority is currently developing ways to measure the financial impact of extreme heat, a spokesperson for the Paris-based authority said. The process may result in the inclusion of heat as a separate category in routine stress tests that gauge banks’ ability to withstand losses, the person said.

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The measure is the latest step by regulators in Europe, the world’s fastest warming continent, to address perceived risks to the banking sector from global warming. According to the European Environment Agency, extreme climate and weather shocks caused more than €200 billion ($230 billion) in damage between 2021 and 2024. The EBA will try to assess how exposed banks’ loan books are to such losses.

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Heat-related damage tends to be less straightforward to measure than losses caused by floods and wildfires, the EBA said. For now, the next stress test measuring European bank resilience will focus on flood risk. The process, which extends into 2027, will be handled by the EBA, the European Central Bank and national supervisors, and will look at risks over a three-year period. 

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Unlike previous stress tests, banks will for the first time face scenarios designed to measure their vulnerability to risks associated with transitioning to a lower-carbon economy as well as to the physical risks that stem from climate change.

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Flood risk can now be measured by linking so-called hazard maps to the location of physical assets, which allows “banks to estimate exposures and potential damages in a relatively consistent manner across institutions,” the watchdog said.

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The annual costs related to floods — the most common category of natural disaster — exceeded €31 billion in 2024 for the EU, compared with an average of €8.6 billion between 1980 and 2024. The European Environment Agency estimates that the cost of coastal floods alone could climb to €1 trillion a year by the end of the century.

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Heat, though not yet its own category in the coming stress tests, “is increasingly recognized as a material climate risk,” the EBA said. 

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The impact of heat waves is visible through data like “labor productivity, sectoral performance, energy demand, agricultural output and broader economic activity,” the watchdog said. That means using macroeconomic variables such as gross domestic product, which would currently “require a different modeling framework,” it said.

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Incorporating heat in the stress tests would also “have added further complexity” and  “placed additional burden on banks and supervisors alike,” the EBA said. 

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The recent extreme heat, which left streets across Europe as empty as during the Covid pandemic, should serve as a warning sign of the potential economic losses ahead, Carsten Brzeski, global head of macro at ING Bank NV, said in a recent note to clients. 

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Northern Europeans often dismiss the problem as something that mostly affects the region’s south; but the north is often vulnerable because its infrastructure isn’t built to cope with such conditions, Brzeski said.