To my mind the most notable exclusion is traded or market risk for banks, which might be where a transition shock would be most likely to manifest – indeed current and recent stresses in energy and commodity markets illustrate this point. As we build capabilities, we will be better able to size the risk and its potential policy implications. We will also learn over time whether the real world looks more like the EA scenario, or if we are living in a ‘late’ or ‘no’ action world. All of this will inform the PRA’s judgements about capital requirements and any other responses to climate risks. Today’s publication is important step forward, but it is not the last word. 1. Climate Biennial Exploratory Scenario 2. For the purposes of this speech, I focus on the prudential regulation and financial stability aspects of climate risk, as opposed to the Bank of England’s other responsibilities as a central bank. 3. The PRA’s supervisory statement on enhancing banks’ and insurers’ approaches to managing the financial risks from climate change 4. The PRA Climate Change Adaptation Report 2021 set out some of these issues in more detail. 5. My colleague Sarah Breeden also reflected on the role of government, central banks and financial firms in the economy’s transition to net zero in a recent speech: Balancing on the net-zero tightrope − speech by Sarah Breeden | Bank of England 6.
Under both the LA and EA scenarios, climate change has broadly been brought under control by the end of the 30 year period. By contrast, with no additional action the impacts will persist well beyond the 30 years of our scenario – incurring substantial economic costs not captured in these estimates. [11] Even sticking within the 30 year bounds of the scenario – and focusing on financial sector impacts – the NAA scenario is pretty grim. Projected impairment rates for banks are up 50% compared with normal levels. And whereas the ‘transition’ scenarios offer clear opportunities for banks to increase their profits by investing the transition, the ‘no action’ scenario offered no such opportunities. Instead the world gets poorer and more uncertain for all sectors, particularly those directly exposed to physical risks. The ‘no action’ scenario is particularly unpleasant for life and general insurers – even sticking to the 30 year window, their losses in this scenario were worse than in the transition. For instance UK and international general insurers, respectively, projected a rise in average annualised losses of around 50% and 70% by the end of the NAA scenario. It’s worth emphasising that these costs would be mostly passed on to consumers through higher premiums. Ultimately, in a ‘no action’ scenario, we would see a reduction in access to lending and insurance for so-called ‘climate vulnerable’ sectors and households. To give an example of what this means, homes at risk of flooding would likely become prohibitively expensive to insure or borrow against.