Bank Of England Introduces Climate Change Stress Test

The Bank of England has set out a new stress test related to the British financial system’s ability to cope with climate change.

The test will scrutinize the resilience of the country's 19 biggest banks and insurers, including HSBC, Barclays and the Lloyd's of London insurance market, to stresses from the shift to a net zero-carbon economy over coming decades as well as the impact of extreme weather.

England’s central bank said the results of the climate change stress test will not be used to determine capital requirements – for now. Due to the experimental nature of the test, only aggregate, rather than firm-by-firm, results are due to be published in May 2022.

The test is based on three scenarios that span 30 years: Early action by governments globally to cut carbon emissions, action that is late, and taking no additional action.

Each scenario will be applied to two main risks: Physical such as fires and floods due to temperature changes, and risks from transitioning to a more climate-friendly business that could bring sudden changes in asset values and the price of carbon.

For banks, the test will focus on the credit risk associated with their banking book, with an emphasis on detailed analysis of risks to large corporate counterparts. For insurers, it will focus on changes in invested assets and insurance liabilities, including accepted reinsurance.

The exploratory exercise will not be used by the Bank of England to set capital requirements but will shape how regulators do their work and help financial firms to model their response to climate risks better.

The Bank of France conducted the world’s first climate stress test, saying in May of this year that French banks should speed up their response to climate change.