Climate: Maltese banks stand to lose, says European Central Bank

An economy-wide climate stress test report by the European Central Bank finds that European countries, including Malta, are more exposed to firms that are subject to high physical risks associated with climate change

Maltese banks are among the most exposed in Europe to firms subject to high physical climate-related risks, including flooding and wildfires.

An economy-wide climate stress test report by the European Central Bank (ECB) highlighted that southern European countries, including Malta, are more exposed to firms that are subject to high physical risks associated with climate change.

Climate risk affects banks mainly through their loan exposures to firms which are subject to increased physical and transition risks. For Maltese banks, roughly 75% of loans are lent to domestic firms, and in turn, domestic risk.

The risk drivers are categorised as transition risks and physical risk. Carbon costs, demand for goods, and technological change and energy efficiency fall under transition risk. Physical risk is based on damaged to physical capital arising from climate-related natural catastrophes, and potentially disruptive effects for firms’ production.

With regards to transition risks, loans from Maltese banks tend to be diversified across high and low emitters. However, the absolute majority of domestic bank loans are exposed to high physical risk, at around 54% of bank loans. Exposures are categorised as high physical risk if a firm’s probability of suffering from a wildfire or a river or coastal flood in a given year is over 1%.

On a wider European level, the ECB highlighted that large companies seem to be the biggest polluters, contributing almost 90% of the overall emissions as against 50% in terms of their total exposures.

Given that large companies produce the greatest emissions, and represent the largest share of loans, the ECB said that they could be seen as the biggest source of transition risk for the banking sector.

A potentially worrying observation is that while bank loans are well diversified across sectors, the highest emitters represent more than 30% of banks’ portfolios. These sectors include manufacturing, and wholesale and retail. The two sectors receive one-third of total euro area bank loans, but this rises to 40% when banks’ exposures to transport and electricity and gas are included.

Malta’s average emission intensity is on the lower side of the Euro-area spectrum, at roughly 700 tonnes of CO2 per euro. The European average stands closer to 775t/CO2 per euro.

In terms of physical risk, Malta scores low. The scores themselves reflect the intensity and magnitude of natural catastrophes over a 30-year-horizon, namely wildfire, flooding and sea level rise.

While Malta is categorised as low risk, it seems that Gozo is more prone to “other hazards” that affect the economy as a whole, as opposed to individual firms.

Malta isn’t alone. Regions located in southern Europe are expected to suffer relatively more from wildfires due to their proximity to the equator. Meanwhile, countries located in eastern and central Europe are expected to increasingly suffer from flooding risk.

Firms exposed to high transition and physical risks tend to be concentrated in resource-intensive sectors, including agriculture, mining, electricity and gas, and water supply and waste. However, vulnerability to high physical risk is spread out far more homogenously across sectors.