The Bank of England on Tuesday set out its first comprehensive stress test of the ability of the British financial system to cope with climate change, saying the results will not be used to determine capital requirements for now.
The test will scrutinise the resilience of the country’s 19 biggest banks and insurers, including HSBC, Barclays, Aviva, RSA and the Lloyd’s of London insurance market, to stresses from the shift to a net zero-carbon economy over coming decades as well as the impact of extreme weather.
“The end result will be more robust management of climate related financial risks across the sector,” BoE Governor Andrew Bailey said in a statement.
As a result of the experimental nature of the test, only aggregate, rather than firm-by-firm, results are due to be published in May 2022, though the outcome could be earlier if no second round of test submissions is needed.
The test is based on three scenarios that span 30 years: early action by governments globally to cut carbon emissions, action that is late, and taking no additional action.
Each scenario will be applied to two main risks: physical such as fires and floods due to temperature changes, and risks from transitioning to a more climate-friendly business that could bring sudden changes in asset values and the price of carbon.
For banks, the test will focus on the credit risk associated with their banking book, with an emphasis on detailed analysis of risks to large corporate counterparties. For insurers, it will focus on changes in invested assets, reinsurance recoverables and insurance liabilities, including accepted reinsurance.
Firms will have to include their corporate customers in the test.
“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,” the BoE said.
The exploratory exercise will not be used by the BoE to set capital requirements, but will shape how regulators do their work and help financial firms to model their response to climate risks better.
Protesters have urged banks like HSBC and Barclays to stop financing fossil fuels.
“By delaying the implementation of climate capital rules, the Bank is undermining its duty to protect financial stability and support net-zero,” said sustainable economy campaign group Positive Money.