Bank of England begins consultation on climate change stress tests
The Bank of England has begun consultation on its proposed 2021 Biennial Exploratory Scenario [BES], which is intended to lay bare the risk of climate change to the financial system and how banks and insurers will react and adapt.
Climate stress tests will operate in a similar way to customary financial stress tests, and the Bank has emphasised the importance of firms and stakeholders continuing to develop innovative means of gauging climate-associated risks in order to ensure the financial system can cope with its outcomes.
The climate stress tests will use exploratory scenarios to size future climate risks and gauge how firms might respond to them.
Bank of England officials told the press that climate change is set to impact every asset worldwide, and it wants to be able to account for the financial risk which comes with such shifts in value and the side effects of banks needing to pay out more to fund climate changing behaviour.
As part of the tests, large banks and insurance firms will need to address risks posed by a range of different climate change scenarios to each of their assets.
The Bank currently recognises two types of climate change financial risks, those being physical risks related to adverse weather, and transition risks which come with modernising and switching over to a greener, low carbon economy.
Bank of England governor Mark Carney said: “The BES is a pioneering exercise, which builds on the considerable progress in addressing climate related risks that has already been made by firms, central banks and regulators. Climate change will affect the value of virtually every financial asset; the BES will help ensure the core of our financial system is resilient to those changes.”
The project could see banks and insurers be required to retain more capital in order to conduct certain types of business, which would then have a knock-on effect on funding the economy.
The final BES outline will be published in the second half of next year, with the results of the exercise scheduled for publication in 2021.