Green Factor Augmented SRISK – A Method to Quantify the Environmental Factor in Systemic Risk Analysis

The paper presents a new method that allows adding the environmental factor (the green factor) to systemic risk measurement, as existing systemic risk measures do not quantify this risk explicitly. We propose a method to extract the green factor from the environmental score (E-score) and augment systemic risk measurement. We take the exposure approach using an existing environmental score as the source of information about bank exposure to environmental risks. We apply the econometric systemic risk model (SRISK) developed by Brownlees and Engle (2017) to quantify systemic risk, and we add the green factor extracted from the Refinitiv Environmental score (E-score) using a conditional sensitivity function. We apply our method empirically to a sample of 19 systemically important European banks from 12 countries between 2006 and 2021. The results show that the size of the impact of the green factor is bigger in three periods of instability: the global financial crisis, the European public debt crisis, and the COVID-19 pandemic. Moreover, the green factor has a higher impact on SRISK, the higher the fragility of a given bank is. This observation holds for banks from developed and emerging countries, for global and local SIFIs. We observe a geographic variability between Western Europe and the CEE region. Higher environmental risk is quantified for the latter, with Russian banks at the bottom of the environmental risk ranking – signifying the severity of environmental risk generated in this country. Our solution is universal in the technical sense and applicable to other systemic risk measures and other environmental scores