## 1. EU Climate Policies and Emission Targets

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### France: progress, sectoral contributions, and targets
- France accounts for 0.9 percent of global emissions and is the second largest GHG emitter in the EU after Germany.
- Emissions in 2022 were 23 percent below 2005 levels.
- Sectoral shares of emissions in 2022:
  - Transport: 32 percent
  - Agriculture: 19 percent
  - Industry: 18 percent
  - Buildings: 16 percent
  - Power generation: 11 percent
- Since 2005, sectoral reductions:
  - Power generation, industry, and buildings: each fell by around 40 percent.
  - Agriculture and transport: fell by 10 percent.
- France mitigation targets (relative to 2005 by 2030):
  - Economy-wide: -52%
  - Non-ETS sectors: -47.5%
  - ETS sectors: -62%
  - Power sector: -40%
  - Industry: -68%
  - Transport: -41%
  - Buildings: -75%
  - Agriculture: -18%
  - Waste: -24%
  - Power, renewable share: At least 33% by 2030; 50% of power production with nuclear energy by 2035
- Projected reductions (comparative assessments):
  - Economy-wide projected reductions:
    - 2021–2030: -22%
    - CPAT: -23%
    - EEA: -33.5%
  - Selected sectoral comparisons (CPAT; EEA where provided):
    - ETS sectors: CPAT: -29%; EEA: -48.1%
    - Power sector: CPAT: -35%; EEA: -56.2%
    - Industry: CPAT: -28%; EEA: -38.9%
    - Non-ETS sectors: CPAT: -24%; EEA: -28.7%
    - Transport: CPAT: -34%; EEA: -28.1%
    - Buildings: CPAT: -19%; EEA: -31.4%
    - Agriculture: CPAT: -10%; EEA: -6.5%
    - Waste: CPAT: -26%
- Scenario outcomes:
  - No-additional-policy trend (IMF CPAT): by 2030 total emissions estimated to decrease by 1 percent below 2022 levels.
  - France’s 2020 NECP policies: expected to contribute to a 33.5 percent emissions reduction by 2030 relative to 2005 (48.1 percent for ETS and 28.7 percent for non-ETS sectors); EEA/EC finds policies do not fully close the gap to Fit-for-55 targets.

### EU climate framework and ETS mechanics
- EU commitments:
  - Reduce emissions to 55 percent below 1990 levels by 2030 (“Fit-for-55”).
  - Carbon neutrality by 2050; intermediate target proposed: 90 percent reduction by 2040 (EC 2024).
- Required annual emissions reductions: increase from 1.2 percent (since 1990) to five percent through 2030 and continuing until net zero.
- EU ETS coverage and dynamics:
  - Covers about 38 percent of total EU GHGs.
  - Present annual allowance volume declines by 2.2 percent; increases from January 1, 2024 to 4.3–4.4 percent annually to comply with Fit-for-55.
  - By 2040, the volume of allowances allocated will be reduced to zero.
  - EU allowance prices: rose to around €90 per tonne in 2021; more recently about €70-75 per tonne.
- New policies and design:
  - Separate ETS for road transportation, buildings, small industry and construction to be introduced in 2027; allowance cap set to an annual linear decline of five percent per year from 2024 emission levels.
  - Recommended use of ETS revenues: green measures and support via the Social Climate Fund for vulnerable households and small businesses.
- Key EU directives highlighted: Renewable Energy Directive; Energy Efficiency Directive; Energy Taxation Directive (ETD) updates; Energy Performance of Buildings Directive; CO2 emissions performance standards for road transportation (all new passenger vehicles and vans to be zero-carbon by 2035).

### Green budgeting and sovereign green bonds
- Green Budget Process:
  - Since 2021, every governmental expenditure must be evaluated using the Green Budget methodology.
  - Actions are tagged according to the six environmental objectives from the EU Taxonomy.
  - The 2024 budget identified additional spending with a favorable impact on the environment for €7 billion.
- Green Sovereign Bonds (Green OATs):
  - First green OAT: January 2017 at 1.75 percent, maturing June 25, 2039.
  - Second nominal green sovereign bond: 2021–2022 at 0.5 percent, maturing June 25, 2044.
  - Inflation-indexed green OAT: 0.1 percent, maturing July 25, 2038.
  - Fourth Green OAT: issued January 2024 at 3 percent, maturing June 25, 2049.
  - Total nominal outstanding amount of green OATs: €72.5 billion.
  - Proceeds allocation 2016–2022: adaptation 16 percent; mitigation 68 percent; biodiversity and pollution control 16 percent.
  - Over 2016–22, building sector and cross-sectoral programs accounted for 34 percent and 26 percent of proceeds, respectively.
  - In 2022, adaptation sector received €0.68 billion—about 8 percent of total spending.
  - Green OATs comply with ICMA green bonds principles and Climate Bonds Initiative taxonomy and trade at yields comparable to corresponding OATs.

### Macroeconomic implications and adaptation needs
- Fit-for-55 transition scenario macro impact:
  - Real GDP could be 1.3 percent lower relative to the baseline by 2030, depending on compensating measures; effect driven by energy-intensive sectors.
- Physical risk profile and damages:
  - Natural hazard event shares in France over past three decades: storms 40 percent, floods 38 percent, extreme temperature events 14 percent.
  - Last decade: share of floods and extreme temperature damage increased from 15 percent (1990s) to 87 percent (last decade).
  - Five-year mean temperatures have exceeded IPCC warming level predictions since 2016.
  - Historical average economic damages: 0.1 percent of GDP per year over the past three decades; peak cost nearly 1.5 percent of GDP in 1999 (cyclone Lothar).
- Adaptation investment needs:
  - IGF assessment: adaptation and ecosystem protection needs €6 billion per year by 2030, out of total €21 billion annual needs.
  - PNACC 3 is in consultation to facilitate implementation of adaptation actions.
- Policy implication:
  - Strengthen integration of adaptation needs into committed public investment via the Green Budgeting mechanism and issuance of green bonds to support adaptation capacity.

---

### 11. Power generation, buildings, and transition pathways

### Climate vulnerability and sectoral physical damages
- Most exposed assets: power generation, buildings, and agriculture (to rising temperatures, extreme rainfall, prolonged droughts).
- Power sector specifics:
  - Nuclear accounted for 63 percent of France’s electricity production in 2022 (56 reactors).
  - Prolonged droughts and water scarcity can reduce hydroelectricity and electricity output from nuclear power.
  - Rising river water temperatures can cause temporary shutdowns impacting cooling of nuclear reactors.
  - Damage from droughts costs power generation and agricultural assets about €2.8 billion per year.
- Buildings and insurance:
  - Average insurance claims in the building sector for natural disasters expected to reach €4.6 billion per year from 2020 to 2050 (France Stratégie).
- Agriculture and labor:
  - Higher volatility in agricultural production can affect food security more than peers (Global Food Security Index).
  - Heat stress can reduce labor productivity and impact tourism flows.

### Macroeconomic implications of the green transition and investment needs
- Modeling uncertainty overview:
  - Keynesian-style models often find positive economic activity effects from aggregate investment; neoclassical models typically find negative but moderate activity losses from carbon pricing and possible crowding out.
  - Outcomes depend on mitigation policy design, revenue recycling, and inclusion of co-benefits.
- Pisani-Ferry and Mahfouz (2023) estimates:
  - Required investment: around €63-66 billion per year (about 2.8 percent of GDP) between now and 2030 from public and private sectors.
  - Potential temporary productivity slowdown: transition may reduce reliance on fossil fuels rather than expand capacity or efficiency.
  - Simulated impacts: potential GDP could decline by 1.5–2 percentage points by 2030, assuming a transitory reduction in productivity growth by 0.25–0.3 percentage point and a decline in actual GDP of roughly 1 percentage point.

### ENVISAGE CGE model Fit-for-55 scenario: calibration and results
- Model features:
  - ENVISAGE: recursive-dynamic, multi-regional, multi-sectoral CGE model across 24 countries/regions and 36 sectors; neo-classical framework; does not account for adjustment costs when reallocating factors.
- FF55 scenario calibration:
  - Carbon price in current EU-ETS and UK ETS increases to $185 per ton in 2030.
  - Three additional policies:
    - Heat pumps: reduce household energy demand by 11 percent; costs calibrated to 0.6 percent of gross annual fixed investment.
    - Energy efficiency regulations in transportation and buildings: costs calibrated to 5.8 percent of gross annual fixed investment in each European country.
    - Easing permits for renewable energy: assumed to increase TFP for wind and solar and lead to 10 percent more renewable generation in 2030 relative to baseline.
  - Policies calibrated together to reach 55 percent emission reduction by 2030 relative to 1990.
  - Only EU, UK and EFTA assumed to achieve their NDCs; rest of world has no mitigation policies.
  - Two revenue recycling assumptions: i) reduction of labor taxes; ii) cash transfers to households.
- Model outcomes:
  - Electricity mix in France in 2030: no energy powered by coal or oil; lower gas and nuclear; higher wind generation.
  - Abatement costs: lower for energy sector; higher for agriculture, transport, industrial processes.
  - Real GDP by 2030 relative to baseline:
    - 1.3 percent lower when revenues are recycled via reduction of labor taxes.
    - 1.6 percent lower when revenues are recycled via cash transfers to households (budget neutral).
  - Most affected sectors: mining, oil & gas, manufacturing, chemicals, utilities.
  - Implication: labor tax reductions are more efficient revenue recycling than cash transfers in this calibration.

### Carbon pricing, coverage, and fiscal options
- Current French carbon pricing:
  - Contribution Climat-Énergie (CCE): €44.6/tCO2; covers mainly heating, transport, and non-ETS 1 industry.
  - Excises on unleaded petrol and diesel: €291 and €196 per tonne of CO2 respectively when used for transportation; reduced for other diesel uses.
  - Plans for further increases suspended after “yellow vest” protests in 2018.
  - New EU ETS for road transportation, buildings, small industry and construction to be introduced in 2027 at EU level.
- Effective coverage and levels:
  - OECD estimate: 71 percent of GHG emissions in France covered by net positive effective pricing, average level €83/tCO2eq.
  - OECD average: coverage 53 percent, average pricing €34/tCO2eq.
  - French Ministry of Energy Transition: average effective carbon price linked to energy combustion € 104/tCO2 in 2022.
  - Industry carbon prices slightly lower than EU peers; around 16 percent of industrial sector emissions not covered by ETS 1.
  - Agriculture effective carbon price rates remain significantly lower due to non-road diesel implicit subsidy.
- Rationale for raising non-ETS carbon pricing:
  - Advantages: economy-wide incentives to reduce energy consumption and shift to cleaner fuels; equalizes marginal abatement costs; mobilizes revenues; domestic co-benefits (reduced air pollution mortality); administratively straightforward via existing excise system.
- International design features:
  - Non-ETS sector prices in European countries vary from €35 to €110 per ton (table referenced).
  - Some countries use progressively increasing levies until transition to ETS 2 market price; others consider price floors for predictability.
- CPAT illustrative scenario: $100 per ton additional non-ETS 1 carbon price
  - Emissions impact: reduce non-ETS 1 emissions by nearly 10 percent below BAU.
  - Welfare and efficiency impacts:
    - Economic efficiency costs: 0.3 percent of GDP.
    - Welfare benefits: 0.1 percent of GDP (from reduced air pollution, reduced road congestion among others).
  - Revenue mobilisation: additional revenues equivalent to 0.8 percent of GDP (see distributional impacts section).

---

### Efficiency of energy prices, distributional impacts, and sectoral mitigation

### Carbon pricing efficiency and design
- Even high carbon prices (e.g., $125 per ton) would not fully achieve mitigation targets; additional sectoral policies needed.
- Economically efficient fuel pricing regime includes:
  - full passthrough of commodity supply costs,
  - a carbon price equal to CO2 damage or aligned with mitigation goals,
  - an excise equal to local externality costs from fossil fuel combustion,
  - and the standard VAT rate.
- Transition strategy:
  - Move from gradually increasing non-ETS carbon price to a domestic price floor for the EU ETS to equalize abatement costs.
  - A carbon price of $100 by 2030 on non-ETS activities could act as a price floor for the ETS.
- Firm-level impact:
  - Energy-intensive firms would see a 1–5 percent increase in input costs due to higher energy prices.

### Distributional impacts and revenue recycling
- Under a $100 per ton carbon price:
  - Loss in purchasing power for poorer households (four lowest income deciles): 1.5 percent of total consumption (1.6 percent for fourth decile).
  - Rural households face higher losses vs. urban households by about 0.5 percent across all income deciles.
  - National minimum wage indexation automatically protects low-income households that use electricity, fuel and/or natural gas for heating.
  - Fossil fuel excise taxes would amount to 3.5 percent of GDP in 2030; additional revenue from the $100 per ton carbon price under CPAT: 0.8 percent of GDP.
  - All additional revenue from higher carbon pricing (0.8 percent of GDP, ~22 percent of total carbon pricing revenue) could fully compensate households in the bottom four income deciles without overcompensation.
- Policy recommendation:
  - Use income-based cash transfers to preserve price signals and avoid subsidizing energy inefficiency; support should not be conditional on energy expenditure.

### Sectoral mitigation policy principles and examples
- Design principles:
  - Sectoral policies should mimic carbon pricing incentives, condition subsidies on household income, provide public goods, promote R&D, and protect against carbon leakage.
  - Target market failures; focus on nascent technologies with positive externalities; be time-bound and transparent; comply with WTO obligations.
- Transportation:
  - 2024 planned direct spending on rail, river, and public road transport: exceed €4 billion.
  - €1.3 billion budgeted for ecological bonus (electric passenger vehicles up to €7,000 varying by income and vehicle price).
  - Ecological malus: €0.8 billion in 2023.
  - Excises: €0.59 and €0.68 per liter for diesel and petrol; €32 per MWh of electricity; VAT 20 percent; heavy goods partial diesel rebate.
  - As of 2024, EV subsidies conditional on production emissions-intensity, excluding about 35 percent of EVs previously eligible.
  - Projections:
    - Road transportation emissions: 94 million tons in 2030 and 66 million tons in 2035 under existing policies.
    - Proposed carbon budget: 75 million tons (2029–2033, 2023 Draft NECP).
    - SGPE provision target: 81 million tons in 2030 (SGPE 2023).
    - Fiscal revenue from road transport expected to decline from around 1.4 percent of GDP currently to close to 1 percent by 2029 due to electrification.
    - Electricity demand from road transportation projected to grow from 4 TWh in 2023 to 31 TWh in 2030 (total national electricity use ≈ 450 TWh in 2023).
  - Policy reforms examined:
    - Convert bonus/malus to linear feebate and introduce heavy goods feebate to create continuous incentives and be revenue neutral (pivot point annually).
    - Current bonus/malus net fiscal cost ≈ €0.5 billion; linear feebate could be designed revenue neutral while maintaining incentives.
    - Distance-based charges (efficient distance charge) estimated to generate revenue > 2.6 percent of GDP in 2030 and reduce road transport emissions to about 77 million tons (vs. 94 million tons under existing policies and 90 million tons for increased EV subsidies).
    - Feebate provides about 0.1 percent of GDP fiscal benefit over current system.
    - Interim proxies for distance charges: annual registration fees or prepayment varying with driving (odometer-based) and tolling on congested roads.
    - Equity: income-based support, improved public transport accessibility, and targeted public transit subsidies for vulnerable households.
- Industrial and R&D support:
  - Example: €659 million grant to Verkor for battery manufacturing; investment tax credits of 20 to 45 percent of qualifying investments.
  - Recommendation: target support to market failures, nascent technologies, time-bound, transparent, WTO-consistent (avoid local content requirements). Netherlands SDE++ cited as an example.

### Buildings: policy mix, costs, and feebate options
- Current measures and budgets:
  - MaPrimeRénov’ budget: €4 billion in 2024 for subsidies for energy-efficient renovations and low-carbon technologies; higher levels for low-income households and deeper renovations.
  - €0.5 billion budgeted for renovating public buildings.
  - Reduced VAT rate of 5.5 percent for energy improvement works: estimated cost €1 billion in 2023.
  - RE2020 sets limits on environmental impact of construction materials; renovation obligations, energy audit requirements, and Energy Performance Certificates (EPCs).
  - Taxes on residential heating (per MWh): Natural gas 8.5; heating oil 10.9; propane 4.7; electricity 32 (EC).
- Cost heterogeneity and market failures:
  - DG Tresor (2023): costs vary from negative for renovations to B or C EPC rating with initial fuel oil heating, to over €1,500 per ton for A-rating renovations when the existing heat source is a heat pump or electric device.
  - Market failures: information asymmetries, owner-tenant misalignment, credit constraints, supply chain rigidity and low-skill labor reliance.
- Subsidy design and MaPrimeRénov’ considerations:
  - Increased support for deeper renovations and comprehensive packages targets lower abatement cost actions and aligns with decarbonization goals (DG Tresor (2023)).
  - Transaction costs, noise, vacancy estimated equal to financing costs of renovation (DG Tresor 2023).
- Feebates in buildings:
  - Potential feebate types:
    - Tax heating fuels proportional to carbon content to finance lower electricity taxes.
    - Lower property taxes for buildings with above-average EPCs and higher taxes for below-average EPCs.
    - Sliding scale of subsidies/taxes by appliance energy efficiency.
  - Feebates applicable to capital appliances (refrigerators: kWh/cubic foot; washing machines; cooling systems).
  - Feebate incorporation into MaPrimeRénov’ possible.
  - Property-tax based feebates practical if EPCs are robust; could be applied to new transfers/new builds to mitigate political resistance.

---

### Transition risk, financial stability, and supervisory implications

### Transmission channels and exposure
- Two primary transmission channels to the financial system:
  - Physical risk: asset damage leading to higher defaults, increased insurance claims, and lower asset values.
  - Transition risk: climate policy, technology, and market sentiment changes affecting corporates not aligned with low-carbon transition, increasing credit risk.
- Box 4 financial exposure key figures:
  - ECB (2023) estimated potential exposure at risk in France around 5.87 trillion euros in expected annual financial assets exposure and corporate revenue losses.
  - BdF (2021) estimated insurance premium increases due to natural disasters between 2.8 and 3.7 percent per year over the next 30 years.
  - Data sources include AnaCredit, Security Holding Statistics, JRC, Copernicus, WRI, NASA; data retrieved March 2024.

### Risk assessment methodology and modeling caveats
- Method:
  - Micro-macro integrated framework: ENVISAGE-derived sectoral output paths → mapped into firm-level corporate balance sheets → assess profitability, leverage, PDs → map to banks’ credit exposures.
  - Moody's EDF 2022 tailored to France used as proxy for initial PD.
- Caveats:
  - Mapping macro sectoral GVA to micro corporate balance sheets and banks’ exposures involves approximation errors due to differing sector classifications.
  - Assumption that the transition starts in 2023 may overestimate risk if mitigation progress is already underway.

### Key sectoral vulnerabilities and banking sector impacts
- Sectoral findings:
  - Chemical and metals sectors exhibit highest default probability increases.
  - Construction and metals show highest PDs; transportation and metals most vulnerable in profitability/leverage assessments.
  - Manufacturing (other energy-sensitive manufacturing) and transport show elevated risk.
- Bank coverage and projected NPLs:
  - Analysis covers 9 largest French banks representing 90 percent of total banking assets.
  - Fit-for-55 transition central scenario: NPLs expected to increase by about 1.5 percentage points by 2030 (energy-intensive sectors focus).
  - More severe scenario (broader sectoral impact): NPLs could increase by about 3 percentage points.
- Sectoral PD projections:
  - Mining sector: most significant projected PD increase by 2030, followed by chemicals.
  - Other energy-sensitive manufacturing and metals: moderate PD increases.
- Comparative studies:
  - BdF (2021) orderly scenario: cost of risk 1.2 times higher in 2050 vs 2025 for all sectors; 2.5 times higher for energy-intensive sectors.
  - BdF disorderly scenarios: GDP loss between 2 and 5.5 percent; cost of risk 3 times higher for energy-intensive sectors in 2050.
  - ECB (2023) accelerated scenario: average percentage point increase in corporate PDs for Euro Area between 2022 and 2030 about 0.2 to 1.2 for lower and upper quartiles, aligning with this chapter’s PD increase estimates.

### Supervisory, disclosure, and prudential recommendations
- Disclosure and supervisory alignment:
  - Ongoing efforts to reach full alignment with ECB supervisory expectations on climate and environment-related risks by 2024.
  - Banks to publish information per CSRD, EU Taxonomy regulatory requirements, and EBA Pillar 3 rules and ESG risks reporting.
  - Enhanced granular disclosure needed given concentration of energy-intensive corporates in bank portfolios.
  - ECB supervisors imposing binding qualitative requirements to 30 banks via SREP; SREP scores will impact Pillar 2 capital requirements.
- Recommendations:
  - Banque de France should continue applying integrated climate risk assessment frameworks to update transition risk impacts on financial stability and ensure adequate capital and contingency planning.
  - Combine bottom-up and top-down approaches for most accurate risk assessments.
  - Banks should accelerate remediation of shortcomings in internal governance and climate-risk management.
  - Integrate transition plans into prudential framework: banks and financial institutions should publish climate transition plans detailing how they will reduce exposure to vulnerable firms.
  - Supervisors empowered to assess progress and require banks to reduce exposures and reinforce targets.
  - Greater efforts needed in France to publish reliable and comparable data on banks’ exposures to energy-intensive firms and on firms’ and banks’ transition plans.

*Source: 1fraea2024002-print-pdf - 1. EU Climate Policies and Emission Targets; Chapter extracts (June 18, 2024).*

### 1. EU Climate Policies and Emission Targets ____________________________________________ 6

### 1. EU Climate Policies and Emission Targets

### France: progress on GHG emissions and sectoral contributions
- France is the second largest GHG emitter in the EU after Germany and accounts for 0.9 percent of global emissions.
- Emissions in 2022 were 23 percent below 2005 levels.
- Sectoral shares of emissions in 2022:
  - Transport: 32 percent
  - Agriculture: 19 percent
  - Industry: 18 percent
  - Buildings: 16 percent
  - Power generation: 11 percent
- Since 2005, emissions reductions have been realized in all major sectors, led by power generation, industry, and buildings—each falling by around 40 percent—and agriculture and transport by 10 percent.

### France mitigation targets and projected gaps
- France targets:
  - Economy-wide: -52% relative to 2005 by 2030
  - Non-ETS sectors: -47.5% relative to 2005 by 2030
  - ETS sectors: -62% relative to 2005 by 2030
  - Power sector: -40% relative to 2005 by 2030
  - Industry: -68% relative to 2005 by 2030
  - Transport: -41% relative to 2005 by 2030
  - Buildings: -75% relative to 2005 by 2030
  - Agriculture: -18% relative to 2005 by 2030
  - Waste: -24% relative to 2005 by 2030
  - Power, renewable share: At least 33% by 2030; 50% of power production with nuclear energy by 2035
- Assessment (Table 1 comparisons):
  - Economy-wide projected reductions:
    - 2021–2030: -22%
    - CPAT: -23%
    - EEA: -33.5%
  - Selected sectoral comparisons (CPAT and EEA estimates included in table):
    - ETS sectors: CPAT: -29%; EEA: -48.1%
    - Power sector: CPAT: -35%; EEA: -56.2%
    - Industry: CPAT: -28%; EEA: -38.9%
    - Non-ETS sectors: CPAT: -24%; EEA: -28.7%
    - Transport: CPAT: -34%; EEA: -28.1%
    - Buildings: CPAT: -19%; EEA: -31.4%
    - Agriculture: CPAT: -10%; EEA: -6.5%
    - Waste: CPAT: -26%

- Under a no-additional-policy trend scenario estimated using the IMF’s Climate Policy Assessment Tool (CPAT), by 2030 total emissions are estimated to decrease by 1 percent below 2022 levels.
- France’s 2020 NECP policies are expected to contribute to a 33.5 percent emissions reduction by 2030 relative to 2005 (48.1 percent for ETS and 28.7 percent for non-ETS sectors), but the 2023 assessment by the European Environmental Agency and the EC finds that these policies do not fully close the gap to Fit-for-55 targets.

### EU climate framework and the ETS (Box 1)
- EU commitments:
  - Reduce emissions to 55 percent below 1990 levels by 2030 (“Fit-for-55”).
  - Carbon neutrality by 2050; intermediate target proposed: 90 percent reduction by 2040 (EC 2024).
- Required annual emissions reductions: increase from 1.2 percent (since 1990) to five percent through 2030 and continuing until net zero.
- EU ETS coverage and dynamics:
  - Covers about 38 percent of total EU GHGs.
  - Present annual allowance volume declines by 2.2 percent, increasing from January 1, 2024 to 4.3–4.4 percent annually to comply with Fit-for-55.
  - By 2040, the volume of allowances allocated will be reduced to zero.
  - EU allowance prices: rose to around €90 per tonne in 2021; more recently about €70-75 per tonne.
- New policies:
  - A separate ETS for road transportation, buildings, small industry and construction will be introduced in 2027, with the allowance cap set to an annual linear decline of five percent per year from 2024 emission levels.
  - Recommended use of ETS revenues: green measures and support via the Social Climate Fund for vulnerable households and small businesses.
- Key EU directives highlighted:
  - Renewable Energy Directive
  - Energy Efficiency Directive
  - Energy Taxation Directive (ETD) updates
  - Energy Performance of Buildings Directive
  - CO2 emissions performance standards for road transportation (all new passenger vehicles and vans to be zero-carbon by 2035)

### Macroeconomic implications and adaptation costs
- Under an alternative Fit-for-55 transition scenario (Fit-for-55 transition scenario referenced in the paper), and depending on compensating measures, real GDP could be 1.3 percent lower relative to the baseline by 2030, driven by energy-intensive sectors.
- Physical risk profile:
  - Over the past three decades, natural hazard event shares in France: storms 40 percent, floods 38 percent, extreme temperature events 14 percent.
  - In the last decade, the share of floods and extreme temperature damage increased from 15 percent (1990s) to 87 percent (last decade).
  - Five-year mean temperatures have exceeded IPCC warming level predictions since 2016.
- Historical economic damages from natural hazards:
  - Average economic damages: 0.1 percent of GDP per year over the past three decades.
  - Peak cost: nearly 1.5 percent of GDP in 1999 (cyclone Lothar).
- Adaptation investment needs:
  - IGF assessment: investment needs for adaptation to climate change and protection of ecosystem at €6 billion per year by 2030, out of a total €21 billion annual needs.
  - The third National Program for Adaptation to Climate Change (PNACC 3) is in consultation to facilitate implementation of adaptation actions.
- Policy implications:
  - Strengthening integration of adaptation needs into committed public investment via the Green Budgeting mechanism and issuance of green bonds can support adaptation capacity.

### Green budget process and green sovereign bonds (Boxes 2 & 3)
- Green Budget Process:
  - Since 2021, every governmental expenditure must be evaluated using the Green Budget methodology.
  - Actions are tagged according to the six environmental objectives from the EU Taxonomy by a working group from the Ministry of Economics and Finance and the Ministry of Ecological Transition.
  - The 2024 budget identified additional spending with a favorable impact on the environment for €7 billion.
- Green Sovereign Bonds:
  - France issued the first green OAT in January 2017 at 1.75 percent, maturing on June 25, 2039.
  - Second nominal green sovereign bond in 2021–2022 at 0.5 percent, maturing on June 25, 2044.
  - An inflation-indexed green OAT at 0.1 percent, maturing on July 25, 2038.
  - Fourth Green OAT issued in January 2024 at 3 percent, maturing on June 25, 2049.
  - Total nominal outstanding amount of green OATs: €72.5 billion.
  - From 2016 to 2022, proceeds allocation: adaptation 16 percent; mitigation 68 percent; biodiversity and pollution control 16 percent.
  - Over 2016–22, building sector and cross-sectoral programs cumulatively accounted for 34 percent and 26 percent of proceeds, respectively.
  - In 2022, the adaptation sector received €0.68 billion—about 8 percent of the total spending.
  - Green OATs comply with ICMA green bonds principles and Climate Bonds Initiative taxonomy and trade at yields comparable to corresponding OATs.

*Source: 1fraea2024002-print-pdf - 1. EU Climate Policies and Emission Targets (June 18, 2024).*

### 11.      Power generation, buildings, and

### 11. Power generation, buildings, and

### Climate vulnerability and physical damages
- Assets most exposed: power generation, buildings, and agriculture are most exposed to rising temperatures and higher risk of extreme rainfall and prolonged droughts.
- Power sector vulnerabilities:
  - Prolonged droughts and water scarcity can reduce hydroelectricity and electricity output from nuclear power (63 percent of France’s electricity production in 2022).
  - Rising river water temperatures can cause temporary shutdowns and impact cooling of nuclear reactors located on the banks of rivers and seaside (56 reactors).
  - Damage from droughts costs power generation and agricultural assets about €2.8 billion per year.
- Agriculture and food security:
  - Higher volatility of agricultural production can affect food security in France more than peers (Global Food Security Index).
- Buildings and insurance:
  - Building sector is highly vulnerable to river floods and heatwaves, increasing requirements for building-based damage reduction measures and passive indoor cooling and in some cases active solutions.
  - The average amount of insurance claims in the building sector for natural disasters is expected to reach €4.6 billion per year from 2020 to 2050 (France Stratégie).
- Labor and tourism:
  - Heat stress can reduce labor productivity and impact tourism flows.

### Macroeconomic implications of the green transition
- Modeling uncertainty:
  - Recent impact assessments assume green transition driven by explicit or implicit carbon pricing and/or an investment shock, without examining the nature of this investment.
  - Keynesian models (aggregate investment increasing) often find positive effects on economic activity or employment.
  - Neoclassical models (carbon pricing or regulations reduce allocation efficiency and/or green investments crowd out more productive investments) usually find negative but moderate economic activity losses.
  - Results depend on mitigation policy design (carbon pricing efficiency), revenue recycling, and inclusion of co-benefits from reduced emissions.
- Pisani-Ferry and Mahfouz (2023) estimates for France:
  - Required investment: around €63-66 billion (about 2.8 percent of GDP) per year between now and 2030 from public and private sectors.
  - Potential temporary productivity slowdown: transition likely to result in a temporary slowdown in productivity as investments reduce reliance on fossil fuels rather than expand production capacity or efficiency.
  - Simulated impacts: potential GDP could decline by 1.5–2 percentage points by 2030, assuming a transitory reduction in productivity growth by 0.25–0.3 percentage point over the next years and a decline in actual GDP of roughly 1 percentage point.

### ENVISAGE CGE modeling and Fit-for-55 (FF55) scenario
- Model description:
  - ENVISAGE: recursive-dynamic, multi-regional, multi-sectoral CGE model (neo-classical framework) optimizing consumption and production across 24 countries/regions and 36 sectors.
  - Limitation: does not account for adjustment costs when factors reallocate across activities; not well suited for short-term transition dynamics or transition paths.
- FF55 scenario assumptions and calibration:
  - Carbon price in current EU-ETS and UK ETS increases to $185 per ton in 2030.
  - Three additional policies:
    - Increase use of heat pumps: calibrated to reduce household energy demand by 11 percent; associated costs calibrated to be 0.6 percent of gross annual fixed investment.
    - Regulations for energy efficiency improvements in transportation and buildings: costs calibrated to be 5.8 percent of gross annual fixed investment in each European country.
    - Easing of permits for investments in renewable energy: assumed to increase total factor productivity of wind and solar power and leads to 10 percent more renewable generation compared to baseline values in 2030.
  - Policies calibrated together to reach the 55 percent emission reduction target by 2030 relative to 1990.
  - Only the EU, UK and EFTA are assumed to achieve their NDCs; rest of world has no mitigation policies.
  - Two revenue recycling assumptions considered: i) reduction of labor taxes; ii) cash transfers to households.
- Model results and sectoral impacts:
  - Electricity mix in France in 2030: no energy powered by coal or oil; lower gas and nuclear power; higher wind generation.
  - Abatement costs: lower for the energy sector (given renewable electricity generation), higher for agriculture, transport, and industrial processes.
  - Real GDP projections by 2030 relative to baseline:
    - 1.3 percent lower when revenues are recycled via a reduction of labor taxes.
    - 1.6 percent lower when revenues are recycled via cash transfers to households (budget neutral).
  - Most affected sectors: energy-intensive sectors such as mining, oil & gas, manufacturing, chemicals, and utilities (coal, gas, and oil).
  - Implication: labor tax reductions are a more efficient revenue recycling method than cash transfers in this calibration.

### Carbon pricing and fiscal policy options
- Current French carbon pricing landscape:
  - Domestic carbon contribution (Contribution Climat-Énergie or CCE) currently equals €44.6/tCO2 and covers mainly heating, transport, and non-ETS 1 industry.
  - Excises on unleaded petrol and diesel are €291 and €196 per tonne of CO2, respectively, when fuels are used for transportation; reduced for other diesel uses (heating and non-transportation commercial activities).
  - Plans for further increases in carbon pricing were suspended after the “yellow vest” protests in 2018.
  - A new EU ETS for road transportation, buildings, small industry and construction will be introduced in 2027 at the EU level.
- Effective carbon pricing coverage and levels:
  - OECD estimate: 71 percent of GHG emissions in France were covered by net positive effective pricing, for an average level of €83/tCO2eq.
  - OECD comparison: OECD average coverage 53 percent, average pricing level €34/tCO2eq.
  - French Ministry of Energy Transition: average level of effective carbon price in France linked to energy combustion was € 104/tCO2 in 2022.
  - Sectoral notes: road transportation carbon prices in line with EU averages but below some neighbors and levels needed to meet emissions-reduction targets under current policy trends; industry carbon prices slightly lower than EU peers due to low excise rates and around 16 percent of industrial sector emissions not covered by ETS 1; agriculture effective carbon price rates remain significantly lower driven by non-road diesel implicit subsidy.
- Rationale for raising carbon pricing in non-ETS 1 sectors:
  - Advantages: across-the-board incentives to reduce energy consumption and shift to cleaner fuels; minimizes mitigation costs by equalizing marginal abatement costs; mobilizes revenues; generates domestic environmental co-benefits (e.g., reduced local air pollution mortality); administratively straightforward and can build on existing excise tax system.
- International comparators and design features:
  - Prices for non-ETS 1 sectors in several European countries vary from €35 to €110 per ton (table reference).
  - Some countries have fixed progressively increasing levies until transition to ETS 2 market price in 2026; others consider price floors to provide price predictability and equalize abatement costs.
- CPAT illustrative scenario: $100 per ton additional non-ETS 1 carbon price
  - Emissions impact: would reduce non-ETS 1 emissions by nearly 10 percent below the Business-as-Usual (BAU) scenario.
  - Welfare and efficiency impacts:
    - Economic efficiency costs of 0.3 percent of GDP.
    - Welfare benefits of 0.1 percent of GDP (improvements from reduced air pollution and reduced road congestion among others offset consumer welfare losses).
  - Revenue mobilisation: the carbon price would mobilize additional revenues (amount not specified in the excerpt).

*Source: Chapter 11 extract from 1fraea2024002-print-pdf (IMF).*

### 0.8 percent of GDP, which could be recycled via cash transfers to offset the price impact on lower-

### Efficiency of Energy Prices and Sectoral Mitigation Policies (France)

### Carbon pricing: efficiency and limits
- Carbon pricing even at relatively high levels (e.g., $125 per ton) would not fully achieve mitigation targets, reinforcing the need for additional sectoral policies.
- An economically efficient fuel pricing regime includes:
  - full passthrough of commodity supply costs (labor, capital, and raw materials),
  - a carbon price equal to the damage from CO2 emissions (or in line with meeting emissions reduction targets),
  - an excise equal to the cost of local externalities caused by fossil fuel combustion,
  - and the standard VAT rate.
- Transitioning from a gradually increasing non-ETS carbon price to a domestic price floor for the EU ETS would help achieve efficient fuel price levels and equalize abatement costs across the economy.
- A carbon price of $100 by 2030 on non-ETS activities could be applied as a price floor for the ETS to achieve fully efficient pricing of externalities.
- Energy-intensive firms would see a 1–5 percent increase in input costs due to higher energy prices.

### Distributional impacts and revenue recycling
- The loss in purchasing power of poorer households (in the four lowest income deciles) is estimated to be 1.5 percent of total consumption under a $100 per ton carbon price (although slightly higher at 1.6 percent for households in the fourth decile).
- Rural households face higher losses vs. urban households by about 0.5 percent across all income deciles.
- The national minimum wage system automatically protects low-income households that use electricity, fuel and/or natural gas for heating through indexation.
- Fossil fuel excise taxes would amount to 3.5 percent of GDP in 2030, of which 0.8 percent of GDP is additional revenue from the $100 per ton carbon price under the CPAT simulation.
- All the additional revenue from the higher carbon pricing (equivalent to 0.8 percent of GDP or around 22 percent of total carbon pricing revenue) could be used to fully compensate households in the bottom four income deciles, or more broadly across the income distribution, for their losses without overcompensating them.
- Policy recommendation: provide support to vulnerable households through income-based measures (e.g., cash transfers) to preserve price signals and avoid subsidizing energy inefficiency; support should not be conditional on household or firm energy expenditure.

### Sectoral mitigation policies: rationale and design principles
- Sectoral policies can complement carbon pricing while balancing fiscal, economic, equity, and acceptability objectives.
- Cost-effective sectoral policies should mimic carbon pricing advantages (similar incentive levels across abatement responses), condition subsidies on household income to address affordability, provide public goods (e.g., public transportation), promote R&D positive externalities, and protect against carbon leakage.
- Sectoral policies should be targeted at market failures, focus on nascent technologies with high positive externalities, be time-bound and transparent to limit fiscal burdens, and be consistent with World Trade Organization obligations.

### Transportation: current policies, projections, and reforms
- Current planned spending and measures:
  - Direct spending on rail, river, and right-of-way public road transport is planned to exceed €4 billion in France in 2024.
  - €1.3 billion is budgeted for the ecological bonus, which subsidizes the purchase of electric passenger vehicles by up to €7,000 varying based on the buyer’s income level and the vehicle’s purchase price.
  - The ecological malus amounted to €0.8 billion in 2023.
  - Excises apply to road transportation fuels at rates of €0.59 and €0.68 per liter of diesel and petrol and €32 per megawatt hour of electricity, in addition to VAT applied at the standard rate of 20 percent.
  - Heavy goods receive a partial rebate on diesel excises.
  - As of 2024, all EV subsidies are conditional to the emissions-intensity of production, which excludes about 35 percent of EVs sold in the French market that were previously eligible for subsidies.
- Emissions and revenue projections:
  - Road transportation emissions are projected to reach 94 million tons in 2030 and 66 million tons in 2035 under existing policies.
  - These compare to a proposed carbon budget of 75 million tons from the years 2029 to 2033 (2023 Draft NECP) and a SGPE provision target of 81 million tons in 2030 (SGPE 2023).
  - Fiscal revenue from road transport is expected to decline from current levels of around 1.4 percent of GDP to close to 1 percent by 2029 due to electrification.
  - Electricity demand from road transportation is projected to grow from 4 terawatt hours (TWh) in 2023 to 31 TWh in 2030, compared to total national electricity use of around 450 TWh in 2023.
- Policy reforms examined and effects:
  - Convert the current bonus/malus system to a linear feebate (continuous incentive) and introduce a similar scheme for heavy goods vehicles to create continuous incentives to reduce vehicle emissions-intensity and to be approximately revenue neutral (pivot point adjustment based on prior year sales).
  - The current bonus/malus system results in a net fiscal cost of around €0.5 billion since bonuses far exceed malus payments; a linear feebate could be designed to be revenue neutral while maintaining incentives.
  - Transitioning to distance-based charges covering the fully external cost of driving (efficient distance charge) is estimated to result in revenue of over 2.6 percent of GDP in 2030 and road transportation emissions of about 77 million tons, relative to 94 million tons under existing policies and 90 million tons for increased EV subsidies.
  - Policy options that do not increase the cost of driving fail to maintain revenue at current levels; a feebate provides about a 0.1 percent of GDP fiscal benefit over the current system.
  - Interim proxies for distance-based charges: annual registration fees or prepayment varying with driving amounts (based on odometer readings) and pollution characteristics, and tolling on congested roads.
  - Equity considerations: manage political and social sensitivities through income-based support, promoting public transport accessibility, and potentially public transit subsidies for vulnerable households.
- Industrial and R&D support:
  - France supports new battery manufacturing processes through direct grants (e.g., €659 million to Verkor) and green investments via investment tax credits of 20 to 45 percent of qualifying investments.
  - Recommendation: target such support to market failures, nascent technologies, time-bound schemes, transparency, and WTO-consistent designs (avoid local content requirements); consider designs like the Netherlands SDE++ (grants to bidders with lowest abatement costs).

### Buildings: policy mix, challenges, and cost heterogeneity
- Current measures and budgets:
  - MaPrimeRénov’ has a budget of €4 billion in 2024 for subsidies for energy-efficient renovations and low carbon technologies (e.g., heat pumps), with higher subsidy levels for low-income households and deeper renovations.
  - €0.5 billion is budgeted for renovating public buildings.
  - A reduced VAT rate of 5.5 percent for energy improvement works is estimated to cost €1 billion in 2023.
  - The Environmental Regulation 2020 (RE2020) sets limits on the environmental impact of construction materials and tightens over time; there are renovation obligations and energy audit requirements and Energy Performance Certificates.
  - Natural gas, heating oil, propane, and electricity for residential heating purposes are taxed at 8.5, 10.9, 4.7, and 32 per MWh, respectively (EC).
- Challenges and cost variability:
  - Abatement costs vary with depth of renovation, pre-renovation energy efficiency (EPC), and occupant socio-economics.
  - DG Tresor (2023) shows costs vary from negative for renovations B or C EPC rating with initial heating sources being fuel oil to over €1,500 per ton if renovations reach A rating and the existing heat source is a heat pump or other electric device.
  - Market failures include information asymmetries between buyers, sellers, and contractors; mismatched owner-tenant incentives; and credit constraints.
  - Supply chain rigidity and reliance on low-skill labor mean renovations should progress smoothly to avoid supply-demand imbalances and keep emissions on track for 2030 and 2050 targets.

*Source: IMF staff estimates and analysis as presented in the supplied content.*

### 33.      The cost-efficiency of subsidies to decarbonization should be studied, through their

### 33.      The cost-efficiency of subsidies to decarbonization should be studied, through their

### Subsidy design and MaPrimeRénov’
- Subsidies under MaPrimeRénov’ have increased for deeper renovations and comprehensive reform packages, promoting renovations and capital good purchases that provide with the lowest abatement costs and are in line with long-term and deep decarbonization objectives and coherent with the other public policy goals like health, household purchasing power, energy independence (DG Tresor (2023)).
- Continued fine-tuning of the relative support levels across abatement responses may be necessary to ensure that incentives target the lowest cost remaining abatement actions, but subsequent changes need to be weighed against the uncertainty that frequently changing policy presents for households.
- Costs outside of direct payments for renovation work, such as transaction costs to find contractors, noise and dust pollution from renovation, and vacancy of homes, are estimated to be equal to the financing costs of renovation (DG Tresor 2023).

### Feebates as revenue-neutral complements in the building sector
- Three types of feebates could be considered in France; they could be applied in tandem or in isolation:
  - A tax on heating oil, LPG, and natural gas proportional to their carbon content could finance lower electricity taxes.
  - Lower property taxes for buildings with above average EPCs and higher taxes for those with below-average EPCs.
  - A sliding scale of subsidies and taxes according to appliances energy efficiency.
- Feebates could apply to capital appliances, such as refrigerators and heating/cooling systems:
  - For refrigerators, energy consumption per unit would be kWh/cubic foot cooled (and the number of units would be cubic feet).
  - Other potential capital goods include washing machines and cooling systems.
  - Such a feebate could be incorporated into MaPrimeRénov’.
- Example feebate schedule formula presented:
  - {CO2 price} × {CO2 per unit of energy} × {energy consumption per unit—industry-wide energy consumption per unit} × {number of units}

### Electricity and fossil fuel tax rebalancing
- A reduction in taxes on electricity used for heating could be financed through higher taxes on natural gas, heating oil, and propane.
- Electricity is currently around twice as expensive as natural gas and 1.5 times the price of heating oil per unit of energy, partly due to disproportionately high tax rates on electricity (around three, four, and eight times higher than that of heating oil, natural gas, and propane).
- Compared to other EU countries:
  - The relative price of natural gas is somewhat low but still above those that have progressed quickly in decarbonizing the building sector (e.g., Sweden).
  - Heating oil and LPG prices are below comparators for households but average-to-high for industry.
- Note: Existing electricity taxes are well above the minimum under the Energy Tax Directive (Taxes in Europe Database).

### Feebates via property tax and implementation considerations
- Feebates applied according to a building’s EPC through the property tax system could promote insulation and lower emissions-intensity of heating equipment, provided EPCs are robust indicators of emissions-intensity.
- Practical considerations:
  - Central government administration of the property tax regime would facilitate application.
  - Effectiveness depends on EPC reliability and coverage (number of buildings with an EPC).
  - Applying the feebate through the property tax, rather than the transfer tax, would allow coverage of more properties but raise equity and political considerations as it would apply to occupants that made building purchase decisions prior to the policy being introduced.
  - One option: apply only to new transfers and newly built buildings—this would need to consider the risk of discouraging the sale of poorly insulated houses.

### Conclusions on carbon pricing and sectoral policies
- An effective carbon pricing strategy:
  - Covers emissions comprehensively.
  - Establishes predictable prices.
  - Aligns stringency with mitigation goals.
  - Exploits fiscal opportunities.
- Policy recommendations:
  - Further raising the carbon price for non-ETS sectors would ensure fossil fuel emissions in France are comprehensively covered by pricing schemes.
  - Coupling the non-ETS carbon price with a gradually increasing ETS price floor would equalize abatement costs across the economy and ensure efficiency in emissions reductions.
  - A higher domestic non-ETS carbon price could subsequently act as a price floor for the future EU-wide ETS in 2027/28.
  - Revenue from carbon pricing can be used for support of vulnerable households.
  - Transparent and extensive communication and consultation with stakeholders on distributional impact and revenue recycling are critical to increase political acceptability.
- Complementary reforms with limited fiscal cost:
  - Convert the bonus/malus for vehicles to a linear schedule with a pivot point set to be revenue neutral, and introduce a separate bonus/malus for heavy goods; projected effects:
    - Save around 0.1 percent of GDP.
    - Reduce sectoral emissions by two percent without increasing prices for the average vehicle purchase.
  - Consider transition to distance-based charges for road transport (initially via annual registration fee or driving prepayment varying with distance, coupled with congestion tolls, and eventually real-time charges).
  - In the building sector, three feebate types reiterated: carbon-proportional tax on heating fuels to finance lower electricity taxes; property tax differentiation by EPC; sliding scale for appliance energy efficiency.

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### E. Climate Transition Risk and Financial Stability

### Transmission channels of climate risk to the financial system
- Climate-related financial impact arises via:
  - Physical risk: exposure to corporates experiencing asset damage leading to increased default risk of loan portfolios or lower asset values; insurers face asset- and liability-side impacts as insurance claims increase in frequency and severity.
  - Transition risk: changes in climate policy, technology, and market sentiment; corporates with business models not focused on low-carbon transition may incur losses on the asset side of financial institutions, increasing credit risk.
- The chapter focuses on transition risk; physical risks are acknowledged as significant but difficult to predict and calibrate into GDP and sector-specific losses (see Box 4).

### Literature and methodological context
- Academic findings: climate events typically reduce insurers’ profitability, bank stability, market returns, and international investment (Battiston, Dafermos, & Monasterolo (2021)).
- Macroprudential considerations: climate risk endogeneity challenges traditional macroeconomic and financial risk analysis (ECB/EBRD (2023)).
- Approaches used in other studies: general equilibrium models and micro-founded firm-level models to assess impacts on corporate balance sheets, default probabilities, and mapping into financial institutions’ exposures.

Box 4 — Financial Exposure to Physical Risks (key figures)
- ECB (2023) estimated financial institutions’ potential exposure at risk in France at around 5.87 trillion euros in terms of expected annual financial assets exposure and corporate revenue losses.
- BdF (2021) estimated an increase in insurance premiums due to natural disasters of between 2.8 and 3.7 percent per year over the next 30 years.
- Data sources and notes:
  - Sources: ESCB calculations based on AnaCredit, Security Holding Statistics, Joint Research Centre (JRC), Copernicus, World Resource Institute, and NASA. Data retrieved on March 2024.
  - Indicators for water stress and wildfires are based on projected data for 2040 and 2030–50 respectively.
  - Protection measures, insurance and collateral are not taken into account.
  - AnaCredit and SHS data are for December 2020.
  - Risk scores are not comparable across hazard types because the scores rely on different methodologies and sources.

### Risk assessment methodology for the French banking sector under a Fit-for-55 scenario
- Approach:
  - Micro-macro integrated framework: use ENVISAGE model to simulate Fit-for-55 scenario and derive sectoral output paths; integrate sectoral outputs into firm-level corporate balance sheets to assess profitability, leverage, probability of default (PD), and map to banks’ credit exposures.
  - Moody's EDF in 2022 tailored to France used as proxy for initial PD.
- Caveat: mapping sectoral GVA from the macro model into sectoral corporate balance sheets and banks’ exposures is subject to approximation errors due to differing sectoral classifications at macro and micro levels.

### Key sectoral vulnerability and corporate risk findings
- Sectoral outcomes from integration:
  - Chemical and metals sectors show the highest default probability.
  - Construction and metals sectors show highest default probability; transportation and metals sectors appear most vulnerable when assessing profitability and leverage.
  - Manufacturing (other energy-sensitive manufacturing) and transport also exhibit elevated risk.
- Rationale:
  - Higher emission profiles, lower profits, and higher leverage increase sensitivity to small shocks.

### Bank exposure, projected NPL increases, and scenario outcomes
- Coverage:
  - Analysis covers the 9 largest French banks representing 90 percent of total banking assets.
- Projected impacts under the Fit-for-55 transition central scenario:
  - NPLs are expected to increase by about 1.5 percentage points by 2030 under the Fit-for-55 transition central scenario focused on energy-intensive sectors (chemicals, metals, and other sensitive manufacturing).
  - In a more severe scenario with a broader impact across all sectors of interest, NPLs could increase by about 3 percentage points.
- Sectoral PD projections (selected observations):
  - The mining sector shows the most significant projected increase in PD by 2030, followed by the chemicals sector.
  - Other energy-sensitive manufacturing sectors and metals exhibit moderate increases in PD.
- Modeling and data caveats:
  - Lack of detailed data on each sector's climate transition progress leads to assumption that the transition is starting in 2023, potentially overestimating the country's risk exposure.

### Comparison with previous exercises
- BdF (2021) orderly scenario (less stringent than Fit-for-55 but over a longer horizon):
  - Cost of risk overall is 1.2 times higher in 2050 compared to its 2025 level for all sectors.
  - For energy-intensive sectors, the cost of risk is 2.5 times as high.
  - Under disorderly scenarios (delayed or sudden), GDP loss could be between 2 and 5.5 percent and the cost of risk is 3 times higher for energy-intensive sectors in 2050.
- ECB (2023) accelerated scenario (closest to this paper’s scenario):
  - Average percentage point increase in corporate PDs for the Euro Area between 2022 and 2030 would be around 0.2 and 1.2 percentage points for the lower and upper risk quartiles, aligning closely with this paper’s PD increase estimates.
  - Increases in the median corporate loan portfolio PD range from 1.6 times to 2 times in 2030 for orderly and disorderly transition, respectively.

*Source: IMF staff estimates; content excerpt from the provided chapter.*

### Conclusions

### Conclusions

### Climate transition and credit risk
- The climate risk assessment in this chapter is a top-down approach which builds on existing literature, including state of the art exercises by BdF, ECB, and recent IMF FSAPs.
- Analysis results point to rising corporate PDs and, in turn, banks’ NPLs in the energy-intensive sectors, with an increase of about 1.5 percentage points by 2030 under the Fit-for-55 transition scenario.
- Ensuring a timely and orderly climate transition will be critical to mitigate the credit risk impact on banks.
- These results underscore the importance of continuing to update and expand climate risk analysis.
- Recommendation: The Banque de France should continue applying such integrated climate risk assessment frameworks to update the impact of climate transition risk on financial stability to ensure adequate capital and contingency planning.
- Recommendation: Combining bottom-up and top-down approaches would provide most accurate assessments of risk.

### Supervisory expectations, disclosure, and remediation
- Efforts are ongoing to reach full alignment with ECB supervisory expectations on climate and environment-related risks by 2024.
- Banks would need to publish information based on the Corporate Sustainability Reporting Standards (CSRD), the EU Taxonomy regulatory requirements, and the EBA’s Pillar 3 rules and ESG risks reporting and disclosures.
- Given sizable concentration of energy-intensive corporates in the banking sector portfolio, disclosure should be enhanced to collect granular data.
- ECB supervisors are including bank-specific climate findings in their Supervisory Review and Evaluation Process (SREP), and imposing binding qualitative requirements to 30 banks (some of which in France too) in their annual SREP.
- SREP scores will impact banks’ Pillar 2 capital requirements which will need to be boosted if banks’ exposures to energy-intensive corporates are high.
- Recommendation: Banks will need to accelerate the effective remediation of shortcomings in internal governance and the management of climate-related risks.

### Integrating transition plans into the prudential framework
- Integrating transition plans into the prudential framework will encourage diversification of investments by financial institutions.
- Banks and other financial institutions should publish climate transition plans on how they plan to reduce their exposure to firms highly vulnerable to climate-related risks, including policy and regulatory changes.
- The revised Capital Requirements Directive encourages banks to prepare prudential plans to address climate-related risks.
- Supervisors are now empowered to assess banks’ progress in addressing those risks as well as to require banks to reduce their exposure to these risks and to reinforce targets.
- Recommendation: Greater efforts are needed in France to publish reliable and comparable data on exposures of banks to energy-intensive firms and on firms’ and banks’ transition plans.

*Source: Conclusions (1fraea2024002-print-pdf).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1fraea2024002-print-pdf.pdf_