Major Bank of England 2021 stress test will look at climate change scenarios
- Published: Thursday, 19 December 2019 10:03
The Bank of England has issued a consultation document which sets out its proposed framework for the 2021 Biennial Exploratory Scenario (BES) exercise, which will test the resilience of the largest banks and insurers to the physical and transition risks associated with different possible climate scenarios. The exercise will also explore the financial system’s exposure more broadly to climate-related risk.
The Bank of England states that "whilst climate-related risks will materialise over decades, actions today will affect the size of those future risks. It is therefore important that firms, and other stakeholders such as the Bank, continue to develop
innovative approaches to measure climate-related risks before it is too late to ensure resilience to them. The BES will use exploratory scenarios to size these future risks and to explore how firms might respond to them materialising, rather than testing firms’ capital adequacy."
The key features of the BES are:
- Multiple Scenarios that cover climate as well as macro-variables: to test the resilience of the UK’s financial system against the physical and transition risks in three distinct climate scenarios. These range from taking early, late and no additional policy action to meet global climate goals.
- Broader participation: both banks and insurers are exposed to climate-related risks, and the action of one will spill over to affect the other. For insurers, this exercise builds on the scenarios developed for this year’s insurance stress test.
- Longer time horizon: is needed as climate-related risks crystallise over a much longer timeframe than conventional risks. The BES proposes a modelling horizon of 30 years.
- Counterparty-level modelling: a bottom up, granular analysis of counterparties’ business models split by geographies and sectors is proposed to accurately capture the exposure to climate-related risks.
- Output: The Bank of England will disclose aggregate results of the financial sector’s resilience to climate-related risk rather than individual firms.