The Bank of England (BoE), which has been at the forefront of understanding climate change as a financial stability risk, is launching industry stress-testing for climate risks.
The U.K.’s central bank published a discussion paper on Wednesday that sets out a proposed stress-testing framework that will examine the resilience of the country’s largest banks and insurers to the physical and transition risks of various climate scenarios, as well as the overall financial system’s exposure to climate-related risk.
“The [climate stress test] is a pioneering exercise, which builds on the considerable progress in addressing climate related risks that has already been made by firms, central banks and regulators,” BoE governor Mark Carney said in a statement.
“Climate change will affect the value of virtually every financial asset; the [stress test] will help ensure the core of our financial system is resilient to those changes,” he added.
The proposed approach will model three different climate scenarios over a 30-year time horizon, based on whether action to combat climate change is taken soon, later or not at all. It will incorporate a “bottom up, granular analysis” of firms’ business models in an effort to accurately capture their exposure to climate-related risks.
The BoE said that it will publicly report on the overall financial system’s resilience to climate-related risks, but not its findings for individual firms.
“None of us can know exactly how climate change will unfold, but we do know that it will create risks to the financial system. I am excited that this ground-breaking exercise will for the first time allow us to quantify this risk and so determine the actions we need to take today if we are to minimise these future risks,” said Sarah Breeden, executive director sponsor for climate change at the BoE.
The proposed stress testing framework is out for consultation until March 18, 2020.
The final framework will be published in the second half of 2020, and the exercise’s results will be released in 2021.