Testing the resilience of the financial system to climate-related risks
Testing the resilience of the financial system to climate-related risks
Oliver Baldock
“Our goal is to build a UK financial system resilient to the risks from climate change and supportive of the transition to a net-zero economy.”
Andrew Bailey, Governor, Bank of England
June 2021 is the new date for the calendar after the Bank of England announced its launch date for the climate stress test exercise. This is welcome news and continues the pressure on financial institutions to address their climate-risk resilience strategy.
The 2021 biennial exploratory scenario (BES) will “test the resilience of the current business models of the largest banks, insurers and the financial system to climate related risks and therefore the scale of adjustment that will need to be undertaken in coming decades for the system to remain resilient.” Andrew Bailey, Governor of the Bank of England announced the exercise will explore three different climate scenarios, testing different combinations of physical and transition risks over a 30-year period. It is expected to help understand how different bank and insurance business models will be affected and how they might respond and improve. We have spoken before about how the current pandemic has demonstrated our ability to adapt and tackle head on devastating scenarios and it’s important to recognise that climate change is an issue that we have been warned about so it shouldn’t come as a nasty surprise.
We must take decisive action for the future
Andrew Bailey puts it very well when he highlights the gravity of this issue and makes clear the Bank of England is keeping climate change top of the agenda despite COVID with this announcement coming on the back of the Bank writing to CEO’s this year with guidance on what needs to be achieved.
“Our goal is to build a UK financial system resilient to the risks from climate change and supportive of the transition to a net-zero economy. In the aftermath of the financial crisis we took far-reaching action to make the financial system more resilient against crises – Covid is the first real test of those changes. The financial system has supported the real economy in the crisis, as it must. We need that same ambition in our approach to climate change. But what is different with climate change is that we know now it is coming, so we can identify where risks will arise and start managing them in advance. Uncertainty and lack of data is not an excuse. We expect firms to make reasonable judgements rather than default to “zero”. UK banks and insurers must work to develop these capital assessments over the coming year and the Bank will be working in tandem to develop its approach to reviewing them.”
Momentum is gathering on this issue and the launch date for BES is an important step forward concerning the Bank of England’s response to climate change. Its results will build a picture of the positioning of different firms in the face of the risks posed by climate change and contribute to the understanding the overall resilience and stability of the UK financial system as we all work towards the government’s commitment to transitioning the economy to net zero by 2050. To embed climate-related financial risks into their risk management processes and respond to the 2021 BES, UK lenders need to start working now to on-board the right data and know-how to assess their exposure. Our team can help you meet the requirements of BES and align your approach to understand climate related risks and its impact.
