Banks and insurers which fail to properly manage climate risks could face a 10% to 15% hit to annual profits and higher capital requirements, the Bank of England said on Tuesday.
In its first comprehensive stress test of how Britain’s financial system’s will cope with climate change and stresses from the shift to a net zero-carbon economy by 2050, the BoE said action now would lower future costs.
Banks and insurers would be able to manage the costs of moving to a net-zero economy if they act now – or else costs will mount, including for customers, the BoE said.
“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,” said BoE Deputy Governor Sam Woods in a speech.
“While they vary across firms and scenarios, overall loss rates are equivalent to an average drag on annual profits of around 10-15%.”
Banks face pressure from climate activists to cut financing to fossil fuel projects.
But Woods said banks and insurers would need to continue financing more carbon-intensive sectors of the economy to help them transition to a low carbon future.
“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.”
In the most severe climate change scenario posed by the BoE, where no additional measures are taken to reduce the rise in global temperatures, banks and insurers test could face total losses of up to 350 billion pounds if they take no action.
“To the extent that climate change makes the distribution of future shocks nastier, that could imply higher capital requirements, all else equal,” Woods said, adding that a debate was to be had.
Properties at risk of flooding would become prohibitively expensive to insure under the severe scenario, the BoE said.
The BoE tested the ability of 19 banks and insurers to understand how climate change will affect their business models and if they hold enough capital to cover climate-related risks like catastrophes, or falls in the value of property and other assets on their books.
The Bank had already said there would be no pass or fail mark due to the test’s experimental nature, and that the results would not determine capital requirements for now.