Bank of England released updated report on climate risks

The financial institution released in March 2023 a report entitled `Climate-Related Risks and the Regulatory Capital Framework`. 

The publication aimed to expand on the bank’s `Climate Change Adaptation Report` (CCAR), which was published back in 2021 and articulated the initial overview of the existing regulatory capital frameworks for financial institutions, banks, and insurers about climate change and the challenges that come with it. The CCAR provided readers with the conclusion that the frameworks were already in place at the time. These included the capital models and credit ratings, which captured climate-related risks partially. 

Details of the updated report

The updated report published in 2023 has a more cautious tone as it concludes that the risk assessment may be incomplete due to capability gaps and regime gasp, meaning that there are still difficulties in estimating and evaluating all the climate risks and the issues that might appear in the process of capturing the risks in the already existing capital regimes. 

These gaps create a certain feeling of uncertainty when it comes to whether banks and insurers are sufficiently capitalised for risks or climate-related losses in the future. The Bank of England mentioned that this uncertainty is a risk for regulators who need to distinguish between qualified risks and unqualified risks as having acceptable or unacceptable risk levels. It also observed that the quantum of capital required for the resilience of climate change losses can be reduced by effective risk management controls, keeping in mind that this absence of controls might suggest the need for a greater quantum of capital. 

The bank will focus on ensuring that financial institutions and firms will make progress in the process of addressing capability gaps in order to improve their identification, measurement, and overall management of the possible climate risks. 

In the future, the Bank of England plans to undertake further and deeper analysis for exploring whether changes to regulatory capital frameworks will be required.  It will focus on developing its capabilities and developing products in order to determine the resilience of the financial system to the risks, supporting initiatives to enhance and improve climate disclosure, promoting high quality, secure, and consistent accounting for climate risks, as well as addressing material regime gaps in capital frameworks. 

The aim of the release is to ensure that climate change risks and challenges and the opportunities that might come from a transition to a net-zero economy are identified and managed in the financial sector. The Bank of England does not propose any specific policy chances, but the publication represents one of the steps that the financial institution took in its process of exploring and determining what changes need to be done to the already existing regulatory capital framework. For this to happen, the institution will take into consideration scenario analysis and stress testing in order to capture `a more forward-looking approach`. 

Bank of England puts an emphasis on the importance of scenario analysis in conjunction with the overall risk assessment, as such practices should be done by other financial regulators as well, including the European Banking Authority and the Federal Reserve. Banks and financial institutions are asked to note the conclusion that increased capital requirements, may be needed to address the absence of controls. This is because of the highlighted use of the Basel III regime to address material climate risks. Following this conclusion, the Bank of England or the Prudential Regulation Authority will have the possibility to address any important and significant capital or supervisory issues or weaknesses.