Bank of England calls for stress tests to handle climate change impact

The Bank of England (BoE) has warned that current gaps in climate reporting are creating uncertainty over whether banks and insurers are sufficiently capitalised for future climate-related losses.

According to the Old Lady, this uncertainty represents a “risk appetite challenge” for regulators, which need to make informed judgements on climate-related risk and act accordingly.

The BoE also found that the “unique characteristics” of climate risks mean that their assessment within capital frameworks requires a more forward-looking approach than used for many other risks. 

Scenario analysis and stress testing were expected to play a “key role” in this, and the BoE anticipated that firms will be make further progress in their implementation.

The findings and recommendations from the BoE follow from its Climate Change Adaptation Report (CCAR), published in October 2021. 

Since then the BoE has engaged with stakeholders to create an updated set of findings, has sent out a call for research papers and hosted a research conference.

Following from the findings of the latest report, the Bank resolved to build its capability to judge the resilience of financial system to climate risks, and support initiatives to enhance climate disclosures.

‘Gaps’ in climate risk analysis

Two kay areas of risk assessment in the climate space identified by the BoE were “capability gaps” and “regime gaps”.

Capability gaps referred to the supposed difficulties inherent in identifying and measuring climate risks. According to the BoE, these challenges might arise due to lack of relevant granular data from firms on their own climate risks, or limitations in modelling techniques to fully incorporate and estimate the impact of climate factors on their counterparties.

Regime gaps refer to challenges in capturing climate risks in capital frameworks, relating to areas such as insufficiently short time horizons.

Moving forward, the BoE committed to support ongoing international and domestic initiatives to enhance climate disclosures by the wider economy needed by banks and insurers to manage and measure risk, including the adoption of International Sustainability Standards Board (ISSB) standards.

Alongside this, the BoE pledged to continue to engage in relevant discussions at international events on how regulatory frameworks and supervisory practices need to be adjusted to account for climate risks.

The BoE also encouraged continuing submission of research from stakeholders, including in areas such as responding to how regulators should deal with the “degree of uncertainty” over the measurement and timing of climate risks as part of policy making.

The Bank’s key work on climate-related risks began in 2015, with a Prudential Regulation Authority report on the impact of climate change on the UK insurance sector.

Last year, the Financial Conduct Authority’s Mark Manning spoke to Net Zero Investor on what the UK regulator’s proposed ESG code of conduct means for responsible investors.