BoE Sets Out Results of 2021 Climate Scenario Exercise for Banks

The key objectives of this climate scenario exercise were to improve climate risk management of banks and insurers, size financial exposures to climate risks, understand challenges to business models from climate-related risks, and analyze the broader implications of such aspects. This exercise included three scenarios, with two scenarios featuring policies to limit global temperature rises (Early Action scenario and Late Action scenario) and a third scenario featuring unchecked global warming (No Additional Action scenario). Each scenario examined the risks that could develop over a period of 30 years. The participating banks and insurers were asked to model how their businesses could be affected in each scenario. All participating banks and insurers have published climate strategies or net-zero transition plans, which they broadly followed in their responses to all three of these climate scenarios. The key results of the 2021 exercise show that:

• UK banks and insurers have made good progress in some aspects of their climate risk management but still need to do much more to understand and manage their exposure to climate risks. To produce better estimates of climate risks in their portfolios, banks and insurers will need to prioritize investment in their climate risk assessment capabilities, both by focusing on their internal modeling and data capabilities and doing more to scrutinize data and projections supplied by third-party providers.
• there is a significant lack of data available on corporates’ current emissions and future transition plans. Banks and insurers will need to prioritize progress on data and will need to put in place interim measures to inform risk management until these data challenges are resolved.
• climate risks captured in the Climate Biennial Exploratory Scenario are likely to create a drag on the profitability of banks and insurers but there is substantial uncertainty around the true magnitude of these risks. Also, climate risks outside the scope of the this scenario (such as trading losses for banks and mortality risk for life insurers) could be material.
• a transition to net zero would materially impact a number of sectors that banks and insurers are exposed to, forcing those in such sectors to adapt their business models or potentially risk becoming unviable over time.
• at an aggregate level, UK banks and insurers are likely to be able to absorb the costs of transition that fall on them. The overall costs will be lowest with early and well-managed action to reduce greenhouse gas emissions and thus limit climate change. Some costs that initially fall on banks and insurers will ultimately be passed on to their customers.
• banks and insurers have a collective interest in managing climate related financial risks in a way that supports that transition over time.
• government's public policy on climate will be a key determinant of the speed and shape of changes in the global economy. 

The findings from Climate BES exercise will inform the Financial Policy Committee’s (FPC) thinking around system-wide policy issues related to climate risk and the Committee’s work in supporting the financial system’s role in the economy’s transition to net zero. The findings will also inform the Prudential Regulation Authority’s (PRA) supervisory policy and approach. In addition, key lessons and themes emerging from the exercise will be shared with the UK government and the international peers of BoE, helping to advance global thinking on how to manage climate-related financial risks, including around the appropriate role of bank and insurer capital requirements.

Related Links

• Press Release
• Results of Scenario Exercise

Keywords: Europe, UK, Banking, Insurance, CBES, Basel, ESG, Climate Change Risk, Stress Testing, Scenario Analysis, FPC, PRA, BoE, Subheadline