The European Central Bank (ECB) launched a supervisory climate risk stress test on 27 January in a bid to assess how prepared banks are for dealing with financial and economic shocks stemming from climate risk.

The test seeks to identify vulnerabilities, best practices and challenges banks face when managing climate-related risk. It focuses on specific asset classes exposed to climate risk, and not on the bank’s overall balance sheets.

The launch of the stress test follows the ECB’s assessment on how European banks are adjusting their practices to manage climate and environmental risks, which revealed that there are major shortcomings.

The analysis, which covered 112 banks, found that none of the banks were close to meeting all supervisory expectations. However, the analysis did acknowledge that banks have taken initial steps towards incorporating climate-related risks.

The stress test, which is set to be conducted in the first half of 2022, is described as a learning exercise for banks and supervisors. The results are expected to be announced in July.

The test is divided into three modules, which include a questionnaire on banks’ climate stress test capabilities, a peer benchmark analysis to assess the sustainability of banks’ business models and their exposure to emission-intensive companies, as well as a bottom-up stress test.

Banks, as well as all the other investment players, are under pressure to accelerate their efforts to tackle climate risks, which is the UN’s 13th Sustainable Development Goal, and is now a pressing priority for many investors looking to expand or relocate their business in the post-pandemic world.