No. 205: Transparency and Real Effects of Climate Stress Tests for Banks

We examine whether microprudential climate stress tests affect banks’ reporting choice, loan portfolios, and environmental performance. With heightened awareness and better data, we expect incentivized banks to expand transparency, adjust lending standards, and reduce their loan exposure to climate risks. Focusing on the 230 largest European banks from 2017 to 2022, we find that participants in supervisory climate stress tests significantly increase their transparency, mainly if they have previously shown commitment to climate issues, face outside ESG pressure, or are more exposed to climate risks. Corporate borrowers of such committed banks reduce their total and long-term loan financing and, in turn, display lower (fixed) assets and sales growth, but only if they are subject to high climate transition risks. In terms of aggregate loan portfolios, we find a shift from long-term to short-term maturities for committed banks but the opposite for the remaining stress-tested banks. The former also increase their climate performance along various dimensions. Our results suggest that, while on average we find no effects, supervisory stress tests can act as change agents and elicit feedback effects for banks facing strong climate-related incentives, impose funding and investment constraints on high-risk borrowers, but also trigger (unintended) substitution to less committed and less tightly regulated banks.