E&F Talk Marta Karaś (Wrocław): E-factor augmentation

The Department for Economics & Finance is happy to welcome Marta Karaś from Wrocław University of Economics and Business who will speak about:

E-factor augmentation – a method to quantify the environmental factor in systemic risk analysis

External guests are kindly requested to register by sending an informal email to Sven.Fischer@brunel.ac.uk

Abstract:

We develop a new method that quantifies environmental risk in systemic risk measurement. We take the exposure approach using an existing E-score as the source of information about bank exposure to environmental risks. We extract the environmental factor (E-factor) from each bank's environmental score (part of the ESG score) and augment systemic risk measurement with it. Our method allows basing the impact of environmental risk exposure on individual characteristics of banks and their systemic risk levels. We apply econometric systemic risk models to quantify systemic risk, and for each, we add the E-factor using a conditional sensitivity function. We demonstrate our method empirically on two systemic risk models: SRISK and ΔCoVaR, using a sample of 20 systemically important European banks from 12 countries between 2006 and 2021. The application exercise shows that the impact of the environmental risk factor is bigger in three periods of instability: the global financial crisis, the European public debt crisis, and the COVID-19 pandemic. Moreover, the E-factor has a higher impact on more fragile banks. This observation holds for banks from developed and emerging countries, for both global and local systemically important financial institutions. Based on the E-SRISK and E-ΔCoVaR rankings, we observe a geographic variability between Western Europe and the CEE region. Higher environmental risk is quantified for the latter, with 2 Russian banks and one Rumanian bank at the bottom of the environmental risk ranking – signifying the severity of environmental risk generated in these countries. Our solution is universal in the technical sense and applicable to other systemic risk measures and other environmental scores, while the ranking methods may be of value for the regulators as they allow to identify the banks that are most prone to losses based on their systemic-risk-based environmental exposure.