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BoE outlines details of climate stress test for UK banks and insurers

BoE outlines details of climate stress test for UK banks and insurers | Insurance Business

BoE outlines details of climate stress test for UK banks and insurers

The Bank of England has published the key elements of this year’s Climate Biennial Exploratory Scenario (CBES), an exploratory exercise aimed at examining the financial risks posed by climate change for the biggest lenders and insurers in the UK.

“Running biennial exploratory scenarios allows policymakers to probe the resilience of the UK financial system to a wide range of risks, and is a tool to enhance participants’ strategic thinking on how to manage those risks,” noted the BoE. “The 2021 exercise explores the resilience of the largest UK banks and insurers to the physical and transition risks associated with climate change.”

According to the central bank, the desired outcomes of the CBES are to size the financial exposures to climate-related risks; understand the challenges to business models from these risks, and gauge participants’ likely responses as well as the implications for the provision of financial services; and assist participating organisations in enhancing their management of the financial risks.

Meanwhile the BoE stressed that the CBES is intended to be a learning exercise and will not be used to set capital requirements. The aim is to develop the capabilities of both the central bank and the participants, given that expertise in modelling climate-related risks is still in its infancy.

The general insurers participating in the CBES are Aviva, Direct Line Group, and the UK entities of AIG, Allianz, AXA, and RSA. Participants from the life insurance space are Aviva, Legal & General, M&G, Phoenix, and Scottish Widows. Ten selected Lloyd’s syndicates are also participating. Taking part as well are large UK banking groups and building societies, including the likes of Barclays and HSBC.

This is the first time that the central bank is testing both banks and insurers, with the goal of capturing interactions between them and understanding the risks presented by climate change across the broader financial system. Exploring transition risk and physical risk, the CBES will use the early, late, and no additional action scenarios. 

Transition risk from climate change spans the risks arising from the significant structural changes to the economy that are needed to achieve net zero emissions, while physical risks are those associated with higher global temperatures.

“[The] exercise will help us size the risks from climate change for both the largest banks and insurers as well as the financial system as a whole,” stated BoE governor Andrew Bailey. “It’s a novel exercise as firms will have to engage closely with their counterparties in order to get detailed data on those counterparties’ exposures to these risks.

“It will stretch the time horizon over which the banks and insurers assess these risks and it will require them to build up their own scenario analysis capabilities, helping them to understand better how they are exposed under different potential climate pathways. The end result will be more robust management of climate-related financial risks across the sector.”

Aggregated CBES results are expected to be released in May 2022. The central bank, meanwhile, said it does not intend to disclose the results of individual firms but system-level results of the financial sector’s resilience to climate change.