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At a time when the European Union’s commitment to climate action shows signs of wavering, the European Central Bank has taken a step forward. From mid-2026, it will introduce a “climate factor” into the criteria used to assess the collateral that counterparties must provide in order to obtain refinancing from the Eurosystem.
The move, also driven by the growing urgency of addressing the increasingly visible consequences of climate change, is designed to manage future uncertainties linked to this global crisis and to strengthen the resilience of European monetary policy.
What is the climate factor?
Floods, wildfires, and heatwaves not only devastate communities and landscapes but also pose significant risks to the economy and financial markets. Unexpected transition shocks, such as shifts in regulations, technologies, or consumer preferences, can also have significant effects. Stress tests conducted across the Eurosystem have shown how extreme events can reduce the value of financial assets, including the collateral accepted by the Central Bank in refinancing operations. A sudden drop in the value of such collateral, triggered, for instance, by the increasingly frequent effects of the climate crisis, could expose the ECB to financial losses.
The value of the collateral that banks present to the ECB is susceptible to a range of factors, not least the uncertainties linked to climate change. As Dirk Broeders, Senior Lead Financial Risk Expert at the ECB, explains to Renewable Matter: “The climate factor may reduce or adjust the value assigned to assets put forward as collateral in refinancing operations. In practice, if the value of the collateral is adjusted, banks will be able to obtain less credit for the same assets.”
The ECB will calculate the climate factor by assessing, for each security, the degree of exposure to transition shocks and uncertainties. This estimate will be carried out at the level of every single financial instrument, ensuring the most appropriate adjustment is applied to each asset.
That adjustment will be based on an “uncertainty score” comprising three elements: a market factor, calculated from expected shortfalls in the adverse scenario of climate stress tests and applied to all assets within a given sector; the issuer-specific exposure, reflecting how individual companies are exposed to transition risks; and the specific vulnerability of each asset, measured by the sensitivity of its market price to unexpected climate events. Fundamentally, the greater an asset’s exposure to climate risks, the lower its value as collateral.
“The primary aim of this measure is to reduce the ECB’s balance sheet risk,” Broeders stresses. “The Governing Council has decided to incorporate climate-related factors into both marketable assets and the shocks linked to the green transition. It has also specified that the scope and calibration of this measure will be reviewed periodically, taking into account data availability, regulatory developments, and advances in risk assessment methodologies.”
The ECB’s green agenda
“A hotter climate and the degradation of natural capital are forcing change in our economy and financial system. We must understand and keep up with this change to continue to fulfil our mandate”, said last year ECB President Christine Lagarde. The introduction of the climate factor is part of a broader package of initiatives set out in the Climate and Nature Plan 2024-2025, which identifies three new priorities that will guide the work of Europe's most important bank for this two-year period.
The first is to address the transition to a green economy, evaluating both its impacts and potential risks. The second concerns the increasingly visible physical consequences of climate change, a fundamental factor given that Europe is the fastest-warming continent. Last but not least, the third priority is to continue to work on nature-related risks, for instance by analysing the economic and financial implications of biodiversity loss and ecosystem degradation.
The ECB’s decision to introduce this climate factor has been welcomed by climate finance observers and those working on the ecological transition. “The European Central Bank’s decision to finally act on its collateral framework sends a powerful message: carbon-intensive assets, like fossil fuels, are less reliable guarantees,” said in a press release, Clarisse Murphy, Central Bank Campaigner at Reclaim Finance, a non-governmental research organisation focused on climate finance. “The proposals must be implemented in such a way as to disincentivize the use of climate destructive assets as collateral. This means careful design to ensure the desired effect.”
Cover: the headquarters of the European Central Bank in Frankfurt, photo Envato