The recent climate change stress test applied to banks shows that climate change means higher risk for banks and insurance companies, suggests the Prudential Regulation Authority CEO
A “major pinch of salt,” said Sam Woods, Deputy Governor for Prudential Regulation and Chief Executive Officer of the Prudential Regulation Authority. He was discussing the Bank of England’s climate change stress reports for banks and insurance companies — the CBES.
The bank was projecting the costs of climate change to key institutions in the financial sector, and at first glance, they don’t seem too bad — “an average drag on annual profits of around 10-15 per cent.”
He added, “These are not the kinds of losses that would make me question the stability of the system, and they suggest that the financial sector has the capacity to support the economy through the transition.”
However, there are buts.
For one thing, the costs depend on which of the three scenarios the bank considered is more likely to materialise.
The three scenarios are:
- “An ‘early action’ scenario where climate policy is ambitious from the beginning, with a gradual intensification of carbon taxes and other policies over time.
- “A ‘late action’ scenario where policy measures are delayed by a decade and then are implemented in a sudden and disorderly way, leading to material economic and market disruption.
- “And a ‘no additional action’ scenario in which governments around the world fail to enact policy responses to global warming, other than those actions already taken.”
Under the first and second of these scenarios, global warming (relative to pre-industrial levels) is successfully limited to 1.8°C by 2050, but under scenario one, it then falls, but under the second scenario stays at that level. Under the third scenario, global temperature levels continue to increase, reaching 3.3°C higher relative to pre-industrial levels by 2050,
For another thing, the third scenario becomes especially damaging and costly beyond the year 2050.
Sam Woods said: “Any positive message needs to be taken with a major pinch of salt: both because there is a lot of uncertainty in these projections and because this drag on profitability will leave the sector more vulnerable to other, future shocks. A world with climate change is a riskier one for the financial system to navigate.”
But what can be done?
Mr Woods then turned to the topic of what needs to happen. You can sum it up in three words/phrases, data, modelling and deep consideration.
He said that key themes are:
- The need for more data. That’s data on customers’ current emissions and transition plans. He said: “This can include looking through complex chains of financial relationships between clients and counterparties to see the underlying emissions.
- “The need to invest in modelling capabilities and doing more to scrutinise data and projections supplied by third-parties.”
- And “the need for some firms to consider more deeply how they would respond strategically to different scenarios, including thinking through the implications of different paths for climate policy.”
But it does boil down to risk, of course. Banks and insurance companies need to factor in the risk of climate change and not taking appropriate measures to mitigate it.
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