By Robin Hamaker-Taylor
In December 2019, the Bank of England published a discussion paper which sets out its proposed framework for the 2021 Biennial Exploratory Scenario (‘BES’) exercise. The 2021 BES aims to test the resilience of the largest banks and insurers to the physical and transition risks associated with different possible climate scenarios, and the financial system’s exposure more broadly to climate-related risk. The Bank opened up consultation on the design of the exercise and sought feedback on the feasibility and the robustness of its proposals by 18 March 2020.
Acclimatise has responded to the BES 2021 discussion paper and is delighted to see the Bank of England progress its oversight and management of climate risks in the UK banking and insurance sector. We are publishing our responses here for the benefit of our clients and those in the financial service sector. In our response, we draw on our extensive experience in the management of physical climate risks in the real economy and with financial institutions, to provide the Bank of England with feedback which we hope can shape the final 2021 BES.
When will the Bank of England climate stress test be released?
The final BES framework is due to be published in the second half of 2020 with the results of the exercise published in 2021. In light of the COVID-19 pandemic, the Bank of England announced on 20th March that it is taking stock of the responses as well as the evolving situation regarding the pandemic. It is not yet clear if the Bank will postpone the BES 2021, however, and the Bank stated it will announce the way forward for this exercise this summer.
Acclimatise develops methods to make the links between the physical climate risk evidence base and banks’ credit risk models
The Bank of England’s climate stress test comes on the back of similar moves from other countries – France announced similar plans in late 2019. Apart from regulators taking action, the financial sector themselves have responded to the climate crisis by beginning to grapple with its climate risk exposure. In 2017-18, sixteen leading banks, UN Environment Finance Initiative (UNEP FI) and Acclimatise, published new methodologies that help banks understand how the physical risks and opportunities of a changing climate might affect their loan portfolios.
The methodologies, published in the report “Navigating a new climate”, were piloted across three climate-sensitive industry sectors: agriculture, energy and real estate. Using the methodologies, banks can begin to assess physical climate risks in their loan portfolios, evaluating the impacts on key credit risk metrics – Probability of Default (PD) and Loan-to-Value (LTV) ratios. The forward-looking assessments offer longer-term insights that go beyond the usual stress-testing horizon of 2-3 years.
An extension of this work began in 2019 – Phase II – which now involves 36 commercial and development banks. Acclimatise are working with banks in Phase II to coordinate and provide training on physical risk methodologies, including modules on hazard data, heatmapping, analytical tools, opportunities, and correlation analysis. A final report summarising the universe of tools and methods available to banks will be available later in summer 2020.
To discuss any of our responses or our physical climate risk analysis services for banks and insurers, please contact Robin Hamaker-Taylor: r.hamaker-taylor(at)acclimatise.uk.com