In its Climate Biennial Exploratory Scenario, the Bank of England is warning banks to take immediate action on climate risks or face a 15% hit to annual profits.
The report explores the financial risks posed by climate change for the largest UK banks and insurers.
BofE deputy governor Sam Woods, says: “The first key lesson from this exercise is that over time climate risks will become a persistent drag on banks’ and insurers’ profitability – particularly if they don’t manage them effectively. While they vary across firms and scenarios, overall loss rates are equivalent to an average drag on annual profits of around 10-15%.”
He adds that the costs of a transition to net zero look absorbable for banks and insurers, without a worrying direct impact on their solvency. They will also be substantially lower if early, orderly action is taken.
“If we are ever to reach net zero, a number of sectors are going to have to adapt their business models on a fundamental level,” says Woods. “As the report sets out, it will be in the collective interests of financial institutions to support counterparties that have credible plans to adapt – and ultimately reduce their exposures to those sectors of the economy that are inconsistent with a net zero policy.”
Somewhat counterintuitively, he suggest banks and insurers need to continue to provide finance to more carbon-intensive sectors of the economy, in order to allow them to invest in the transition.
“Cutting off finance to these corporates too quickly could prove counterproductive, and have wide-ranging macroeconomic and societal consequences, including through elevated energy prices – potentially akin to those whose negative effects we are experiencing today,” he says.
Woods states the bank intends to give firm-specific feedback to participants from the exercise.
However, the key themes include the need for more data on, and understanding of, customers’ current emissions and transition plans. This can include looking through complex chains of financial relationships between clients and counterparties to see the underlying emissions.
In addition, it highlights the importance to invest in modelling capabilities and doing more to scrutinise data and projections supplied by third parties.
Last but not least, firms are advised to consider more deeply how they would respond strategically to different scenarios, including thinking through the implications of different paths for climate policy.
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