UK banks and insurers to be tested on climate crisis response plans

UK banks and insurers will be forced to reveal how exposed they are to the climate crisis and how they would respond to the effects of a a temperature rise of up to 4C under the Bank of England’s first climate stress tests.

The Bank has put forward proposals to test the performance and health of the UK financial system for a range of climate-linked financial risks, including the failure of governments and consumers to take action.

The tests are expected to uncover the extent of the financial sector’s exposure to climate risks, and gauge company responses that could cause spillover effects for the global economy.

However, the Bank will not identify individual businesses through the tests and will release only aggregate results for the banking and insurance sectors.

 

Threadneedle Street has, however, not ruled out releasing individual results in the future, and plans to use the initial reports to inform how it supervises each company.

The tests, to be released for the first time in 2021, will cover the same UK banks subject to financial stress testing, including HSBC, Barclays, Standard Chartered, Royal Bank of Scotland, Santander UK, Lloyds and Nationwide. By 2021, CYBG – rebranded as Virgin Money – will also be included. About 39 insurers are expected to be tested on their climate resilience.

The testing will cover three scenarios, including “early policy action”, where the transition to a carbon-neutral economy is clear and decisive, resulting in the global temperature rise staying below 2C, in line with the 2015 Paris climate agreement.

In a second “late policy action scenario”, global climate targets will also be met, but the transition will have been delayed by 10 years, leading to more drastic and immediate action that could cause an economic shock.

In the final scenario, governments fail to introduce policies to address the climate emergency, and companies and consumers do not change their behaviour. Global temperatures increase “substantially” – by about 4C – by 2080, resulting in rising sea levels and more frequent, extreme weather events such as flash floods.

Drastic environmental changes around the world would damage property, infrastructure and farmland, disrupt business supply chains, and lead to mass migration and deaths, the Bank said.

“This reduces asset values, results in lower profitability for companies, damages public finances and increases the cost of settling underwriting losses for insurers,” it said. Spillover effects such as lower output and productivity would compound those problems.

The environmental risks of climate change are already affecting financial companies in the UK, with about 10% of domestic mortgages exposed to properties in flood-risk zones. Some British banks are also exposed to regions extremely vulnerable to climate change, such as south-east Asia. Countries along the equator are expected to be uninhabitable for much of the year due to high humidity under a 4C-rise scenario.

If temperatures increase to that level, rising ocean acidity would wipe out coral reefs, shellfish and plankton, starving the oceans of oxygen and leading to a decline in sea life, environmental experts have warned. Saharan deserts are expected to expand into southern and central Europe, while the vast majority of the the global population would have to migrate to northern regions, where farming would be viable.

According to a study by Solomon Hsiang and Edward Miguel of University of California, Berkeley, and Marshall Burke of Stanford University, unmitigated global warming would lead to a 23% loss in per capita earning globally by the end of the century.

The Bank’s proposals will go out for consultation until March and it is requesting feedback from financial companies, climate scientists, economists and other industry experts.

The Bank’s governor, Mark Carney, said the tests were 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.”

He added that the tests would “help ensure the core of our financial system is resilient to those changes”.

Carney is taking on the role of UN special envoy for climate action and finance after he steps down from the Bank next month. His main focus will be on mobilising private finance to invest in schemes that will help achieve the Paris goal of limiting global temperature rises to 1.5C.