Energy transition may be subprime moment for European banks

A rapid and chaotic energy transition would leave Europe’s biggest banks in financial peril comparable to the subprime crisis that United States lenders faced in 2008.

The 11 largest banks in the European Union, including BNP Paribas SA, Deutsche Bank AG and Unicredit SPA, have €532bil (Us$648bil or RM2.67 trillion) of investments and loans financing everything from extraction to transportation of fossil fuels, equivalent to 95% of their total common equity tier 1 capital (CET1), according to a report from think tank Rousseau Institute, Friends of the Earth France and fellow environmental nonprofit Reclaim Finance.

A sudden drop in value of these “fossil-fuel assets” would deplete the banks’ capacity to absorb losses and might even leave them vulnerable to bankruptcy, the researchers said.

While oil, gas and coal have fuelled economic development since the industrial revolution, the level of carbon dioxide in the atmosphere is at record levels.

Scientists have been warning that to avoid the most catastrophic impacts of climate change and reach the Paris Agreement’s goal of keeping global warming below two degrees Celsius, emissions must be cut in half by the end of this decade and reach net zero by 2050.

For banks, the risk is that assets tied to fossil fuels plummet in value, and possibly become illiquid, as business activities inconsistent with a two degrees-or-less world are abandoned.

“The devaluation of fossil assets held by banks, following the inevitable ecological transition, could produce significant turbulence or even generate a new financial crisis,” according to the report.

“The loss in value, whatever the speed, could put banks in a situation of bankruptcy.”

The potential for so-called stranded assets “mirrors the subprime mortgage crisis,” the report said.

If fossil-fuel assets were to lose 80% of their value, like what happened to the price of mortgage bonds securitising low-quality homes during the last financial crisis, France’s Credit Agricole SA and Societe Generale SA wouldn’t have sufficient equity to cover their losses, and the equity of Germany’s Deutsche Bank AG and Commerzbank AG would be almost exhausted, the report said.

Fossil-fuel assets are equivalent to 131% of Credit Agricole’s CET1 capital, 109% for Deutsche Bank and 68% at Spain’s Banco Santander SA, according to the research.

And that’s just “the tip of a gigantic iceberg” when it comes to banks’ potential exposure to transition risk from other industries.