Summary
- BoE says climate is a ‘first-order’ strategic issue
- Costs are manageable as customers will largely pay
- Test outcome won’t affect capital for now
- Fitch says the test is toughest by a central bank so far
- ECB plans to test this year, Fed yet to undertake the test
Banks and insurers that do not control climate risks as a “first-order” issue could suffer a 10% to 15% loss in annual profits and increased capital requirements, the Bank of England (BoE) said on May 24.
In its first extensive stress test of how Britain’s financial system will deal with climate change and the switch to a net zero-carbon economy by 2050, the BoE said action now would decrease future costs. BoE Deputy Governor Sam Woods said in a speech:
“The first key lesson from this exercise is that over time climate risks will become a persistent drag on banks’ and insurers’ profitability – particularly if they don’t manage them effectively. While they vary across firms and scenarios, overall loss rates are equivalent to an average drag on annual profits of around 10-15%.”
The Bank of France was one of the first central banks to take part in a climate stress test of banks and insurers, but Fitch said the BoE test was the hardest by a central bank so far. The European Central Bank has scheduled a test for this year, while the U.S. Federal Reserve has yet to begin such an exercise.
Banks throughout the world encounter pressure from climate activists to end the financing of fossil fuel projects. David Barmes, senior economist at Positive Money, which advocates for a sustainable economy mentioned:
“Outright restrictions on lending to new fossil fuel projects must now be on the table.”
But Woods said banks and insurers would need to keep on financing more carbon-intensive sectors of the economy to help in their shift to a low carbon future.
“Cutting off finance to these corporates too quickly could prove counterproductive, and have wide-ranging macroeconomic and societal consequences, including through elevated energy prices – potentially akin to those whose negative effects we are experiencing today.”
HSBC, NatWest, Lloyds, Aviva, and the Lloyd’s of London insurance market were among the group tested for early, late, and no further action to climate change over three decades.
In the most acute scenario created by the BoE, where no further measures are taken to decrease the rise in global temperatures, banks and insurers tested could suffer total losses of 334 billion pounds ($417 billion) over thirty years.
“To the extent that climate change makes the distribution of future shocks nastier, that could imply higher capital requirements, all else equal,” Woods said, adding a discussion was to be had.
Properties in danger of flooding would become unaffordably expensive to insure under the severe scenario, the BoE said.
The BoE tested the ability of nineteen banks and insurers to recognize how climate change will impact their business models and if they hold sufficient capital to cover drops in the value of the property and other assets on their books or climate-related risks like catastrophes.
Previously, the bank had already said that the test would not have a pass or fail mark because of its experimental nature, and the results would not dictate capital requirements for now.
The Bank of France said in 2021 that French banks should accelerate their response to climate change.
($1 = 0.8002 pounds)
