financial stability risks per se. Moreover, their typically limited size and interconnections with the commercial banking system means their failure has no significant impact on financial stability. Ensuring the safety and soundness of CGSs is essentially a matter of public policy effectiveness, given that many SMEs depend on credit guarantees for financing working capital and investment. A financially sound and healthy CGS gives lenders the confidence to leverage it to extend lending to small businesses. Ensuring the financial sustainability of CGSs is also a fiscal imperative, given the contingent liability they represent for the government.

**In particular, this paper focuses on a sample of European CGSs.** Europe as a whole is heavily exposed to transition risks, which may have been exacerbated by the recent energy crisis, linked to the war in Ukraine, and the potential this poses for an associated delayed phase out of fossil fuels. The region is also significantly exposed to physical risks, especially heatwaves, droughts, floods, and sea level rise, with significant between- and within-country variation. At the same time, Europe is a frontrunner in climate policies, with ambitious targets in terms of greenhouse gas (GHG) emission reductions and a well-established yet evolving policy framework. Europe is also a region where CGSs are a historically important component of the financial system, facilitating access to finance for millions of small businesses that are relatively dependent on bank financing for their operations. CGSs in Europe can play an important role in supporting green investment by SMEs, both on the mitigation and adaptation fronts.

**This paper assesses the vulnerability of European CGSs to both transition risks and physical risks.** The paper is based on unique sectoral and spatial data from 29 European CGSs, accounting for EUR 278 billion or 84 percent of the total outstanding guarantee volume of the European Association of Guarantee Institutions’ (AECM) members as of end-2020. We then link CGSs’ guarantee portfolio data to a set of sectorally and spatially disaggregated transition and physical risk vulnerability indicators, which allows us to identify the portfolio shares at risk per indicator. We also identify sectors that are most relevant for CGSs to focus on by creating a transition risk score which combines exposure with GHG intensity. Finally, we conduct a stylized stress test to assess potential financial losses that CGSs could incur under adverse climate-related scenarios. To our knowledge, we are the first to investigate the vulnerability of CGSs to climate-related financial risks.

**Results show that European CGSs’ vulnerability to climate-related financial risks is non negligible.** We estimate that about one-third of CGSs’ guarantee portfolios is towards sectors that have elevated exposure to a disorderly energy transition. This is partly mitigated by the finding that most of the exposures are towards sectors that are in the 30<sup>th</sup> -60<sup>th</sup> percentile of GHG intensity. Combining guarantee exposures with GHG emission data, we also find a relatively high degree of portfolio concentration, with 72 percent of the transition risk for CGSs driven by five sectors. European CGSs are also exposed to a broad range of climate-related physical risks, especially wildfire (56 percent aggregate CGSs’ portfolios in our sample), coastal flood (41 percent), and river flood (6 percent). Within CGSs’ portfolios, we estimate that 24-31 percent of guarantees are towards sectors that have elevated exposure to climate change and weather

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