The end result will be more robust management of climate-related financial risks across the sector, said BOE governor Andrew Bailey.
The BOE (Bank of England) has published its Climate Biennial Exploratory Scenario (CBES), which it will use to stress test the UK’s largest banks and insurers to assess their exposures to climate-related financial risks.
“This is the first time we are testing both banks and insurers to allow us to capture interactions between them and understand the risks presented by climate change across the financial system,” said BOE in a statement.
The CBES stress test is an exploratory exercise and will not be used by the bank to set capital requirements. Instead, it will be used to inform policymaking efforts and the PRA’s (Prudential Regulation Authority) future supervisory approach.
For banks, the stress test will focus on credit risks in the banking book, with an emphasis on detailed analysis of the risks posed by large corporate counterparties. For insurers, it will focus on changes in invested assets, reinsurance recoverables and insurance liabilities, including accepted reinsurance.
Three scenarios will be used, namely those involving ‘early’, ‘late’ and ‘no additional action’ to explore both the transition and physical risks associated with climate change.
The primary objectives of the CBES assessment are to quantify financial exposures of individual firms and the financial system more broadly, facilitate a better understanding of the potential challenges to their business models, and help firms improve their risk management frameworks and adopt a strategic view on climate risk.
The BOE noted that experience and expertise in modelling climate-related risks is still relatively immature, and that the CBES will help it, as well as banks and insurers, to build their capacity to withstand climate risks. It also provides an opportunity for financial firms to work with major counterparties to understand their vulnerability to climate change.
The results of the CBES exercise are expected to be published in May 2022. “The end result will be more robust management of climate related financial risks across the sector,” said BOE governor Andrew Bailey.
The BOE release comes after Banque de France published the results of the world’s first climate stress tests, conducted by the ACPR (French Prudential Supervision and Resolution Authority).
France’s pilot test was conducted on nine banks and 15 insurers to measure resilience to common “scenarios” like a slow response to climate change. The results came with a recommendation for French banks and insurers to speed up their response to climate change.
The ACPR had said its pilot would help to inform the BOE’s own climate stress test and a test the ECB (European Central Bank) will conduct in 2022.