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The Bank of England’s Climate Exploratory Scenario – Estimating Exposures and Adding Support to the UK’s Financial Stability

In DBRS Morningstar’s view, the Bank of England’s Climate Biennial Exploratory Scenario (CBES) exercise has provided a useful assessment of the exposure of large UK financial institutions to climate risks, as it provides a first in its kind thorough insight into the UK banks' and insurers’ capacity to handle transition and physical risks under different scenarios. It has also highlighted that there are areas for improvement and risks posed by financial institutions' climate strategies to the wider economy. Moreover, the CBES complements the financial supervisor’s toolkit to preserve financial stability. In this commentary, we take a look at the key takeaways from the exercise and at the implications for financial stability.

Key Highlights
• Based on banks’ and insurers’ projections of climate losses in the CBES exercise, the estimated costs to large UK financial institutions from climate change appear manageable considering the BoE's plausible representations of what might happen.
• The exercise has allowed the BoE to assess the potential adverse effect on the UK economy of the collective banks’ and insurers’ net-zero plans.
• The CBES adds to the BoE's supervisory toolkit to assess the accumulation of risks and to enhance financial stability.

“By assessing the exposure of UK financial institutions to climate risks and by understanding how the net-zero plans of banks and insurers could affect the economy, the CBES helps to address the accumulation of risks in the financial system. This supports financial stability in the UK”, said Adriana Alvarado, Senior Vice President in the Global Sovereign Ratings Group.

“The exercise has estimated the financial exposure of participants to climate risks over a 30-year horizon under three different scenarios, and projection of climate losses that could materialise are expected to weigh on the profitability. However, we also note large UK banks should be in a position to adjust through retained earnings and pass on increases in lending rates to sectors where risks increase”, said Vitaline Yeterian, Senior Vice President, Global FIG.

“Both general and life insurers are subject to reputational risk and social pressure, which is accelerating their exit from carbon-intensive industries, through reduced investing and/or underwriting in these sectors. While the BoE expects insurers could increase the premiums to insure against climate risks, consumers’ affordability of general insurance products could materially deteriorate in the worst case scenario, leaving many UK households without viable protection”, said Marcos Alvarez, Senior Vice President, Head of Insurance.