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Bank of England publishes climate stress test proposals for financial services

18th December 2019 - Author: Luke Gallin

The Bank of England (BoE) has outlined proposals for the 2021 Biennial Exploratory Scenario (BES) exercise, designed to test the resilience of banks, insurers and the financial system to both the physical and transition risks from climate change.

financial-climate-riskThe BES looks to expand on the current efforts being made by banks and insurers in addressing risks related to climate change. While knowledge around the changing climate appears to be growing, much remains uncertain and BES aims to improve the resilience on the financial system against the impacts of climate related risks.

The Bank of England has today published a discussion paper which sets out its proposal to stress test the sector, leveraging exploratory scenarios to size these future risks and to examine how banks and insurers might respond to them materialising.

As outlined by the Bank of England, the key features of the BES include multiple scenarios that cover climate as well as macro-variables; broader participation from firms; longer time horizon – with the BES proposing a modelling horizon of 30 years; counter-party level modelling; and output.

Governor of the Bank of England, 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 Executive Director sponsor for climate change, Sarah Breeden added: “None of us can know exactly how climate change will unfold, but we do know that it will create risks to the financial system. I am excited that this ground-breaking exercise will for the first time allow us to quantify this risk and so determine the actions we need to take today if we are to minimise these future risks.”

The Bank of England has requested feedback on the design of the exercise and the robustness of the proposals by March 18th, 2020. The final BES framework is to be published in the second-half of next year, with the results of the exercise expected to be published in 2021.

In response to the Bank of England’s discussion paper, Keith Richards, Managing Director of Engagement at the Chartered Insurance Institute (CII), has welcomed the Bank’s proposals for climate stress testing across financial services.

“Financial markets are at the heart of the global economy and our society, so to ensure we can respond to the implications of climate change, we need to understand the nature of the physical and transition risks we are exposed to.

“The insurance market already plays a huge role in helping to mitigate and respond to climate related disasters, and our profession will continue to benefit from the expertise being developed in this area in response to future risks.

“The CII views the understanding of climate change related risks as a crucial skill for people to have in our profession, and this has become a part of a number of training courses and qualifications we offer to our members. We will work with the Bank of England on the finer details of these proposals as they are developed,” said Richards.

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