UK banks face up to £225bn in climate-related credit losses, stress test finds

UK banks and insurers that fail to manage the risks associated with climate change could suffer a 10-15 per cent hit to their annual profits, the Bank of England warned on Tuesday.

The results of the regulator’s inaugural “climate stress test” indicated that banks could incur up to £225bn in credit losses by 2050, while insurers’ asset values could fall 15 per cent under a worst-case scenario.

But the analysis suggested that the losses would be “absorbable for banks and insurers, without a worrying direct impact on their solvency”, said Sam Woods, head of the BoE’s Prudential Regulation Authority. The exercise will not be used to set higher capital requirements, he said.

The stress test looked at the exposure of the largest 19 UK banks and insurers to climate-related risks — both physical risks, such as flooding, and “transition” risks, such as potential regulatory or policy changes.

The analysis tested companies’ end-2020 balance sheets against three climate scenarios: an orderly transition, in which temperatures increase to 1.8C of warming by 2050, a disorderly transition where temperatures also increase to 1.8C of warming but action is delayed and more chaotic, and no additional action, where no further policies are introduced and global temperatures increase by 3.3C relative to pre-industrial levels.

The issue of banks’ responsibilities on climate was thrown into the spotlight last week, when a senior HSBC executive said central bankers were overstating the financial risks of warming in an attempt to “out-hyperbole the next guy”.

Stuart Kirk, global head of responsible investing at the bank’s asset management division, has since been suspended pending an internal investigation into his comments.

Woods said on Tuesday that the comments had been “ill judged”.

“I do not think that you could attach the word ‘hyperbole’ [to the stress test results],” he said.

In his speech, Kirk noted that HSBC’s average loan length was six years and suggested that meant long-term risks were overstated.

The BoE’s stress test envisages that banks and insurers do not change the composition of their balance sheets. The regulators acknowledged that was unlikely to be true in reality.

Insurers stood to lose out both from the impact of climate change on their investments and through higher payouts for flood and other damage, the BoE said. Insurers’ assets could fall 8 per cent in the most benign scenario, but 15 per cent under the most extreme scenario, with life insurers particularly exposed.

Inland and coastal flooding was likely to drive up claims in the UK. In the worst-case scenario, about 7 per cent of UK households that insurers currently cover could become uninsurable, the BoE said.

“It’s worth emphasising that these costs would be mostly passed on to consumers through higher premiums,” said Woods.

Although the stress test is not being used to alter capital requirements, as in a standard remediation process the BoE could ask a company that it believed was not sufficiently managing its risk exposure to hold extra capital.

Woods said any move to penalise banks for holding “brown”, or carbon-intensive” assets would “have to be a political judgment”. He said one question that could be worth looking at in future was the impact on the financial sector of a “transition shock”, in which government policy changed suddenly. The BoE has not decided whether it will rerun the climate stress test in future.