The Bank of England will launch its stress tests on U.K. banks and insurers against the effects of different climate change scenarios in June 2021, BoE Governor Andrew Bailey said in a speech.
The BoE will test the balance sheets of the biggest banks and insurers in the country to see how they would cope with more frequent severe weather events like floods and subsidence. It will also test them on the effect of a sudden fire sale of "at-risk assets" and on when banks suddenly step back from lending to high-carbon sectors or insurers sharply increase the price of flood insurance.
The exercise will test the country's financial institutions on three different climate scenarios, with tests carried out on different combinations of physical and transition risks over a 30-year period.
In 2019, the central bank announced plans to launch a climate stress test exercise and published a discussion paper setting out its proposed approach to the test, which was delayed because of the onset of the coronavirus crisis. Bailey said the BoE used the extra time to continue its work on the design of the exercise.
In addition to building on the feedback it received in response to that paper, the BoE will share more detail on some key aspects of the exercise, like data requirements and scenario variables, with participants.
The results of the stress tests will not be used to size firms' capital buffers, but firms must assess how climate risks could impact their business and review whether additional capital is needed, Bailey said.
He noted that the progress on climate change issues has to focus on data and disclosure. He urged financial firms and their clients to use the framework by the Taskforce for Climate-related Financial Disclosures and the latest tools available to measure, model and disclose the climate risks and opportunities they are exposed to today and in different future climate scenarios.
The BoE is working with the Treasury and other regulators to consider the U.K.'s approach to climate disclosure. The government made a commitment to transitioning the economy to net-zero emissions by 2050.
"We all know an economy-wide transition to net zero is a huge task," Bailey said. "But our experience with COVID has powerfully demonstrated our ability to adapt which should give us all comfort that the task we face should be achievable."
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