BoE provides update on risks from climate change

Anil Kashyap, a member of BoE’s Financial Policy Committee, has delivered a speech about the BoE’s work to ensure UK banks and insurers understand the risks from climate change. He discussed the following issues:

  • Modelling climate risk will require firms to look at their customers differently than they do now. For many customers, business as usual will become impossible to sustain in several circumstances, including if the product being sold becomes inconsistent with a world that features much higher carbon prices. Firms will also need a lot of non-standard information and reporting requirements will need to change to make this information available.
  • Firms differ greatly in the degree of granularity they use in their modelling. Some firms think about top down approaches that suppose all firms in a sector are identical so that a single loss assumption for the sector is the essential driver of the results. Others use a very detailed bottom up approach that take borrower specific conditions into account.
  • Firms rely on third party consultants to assist with their modelling. It will take time for firms to hire the staff that is needed and build up competence.

Mr Kashyap highlighted that banks and insurers need to improve the way in which they report on climate risks and he suggested some questions that senior managers should ask to keep them on the right track, including:

  • How much extrapolation are you having to do because of missing data? Perhaps more importantly, how are the gaps being filled in?
  • Do you know which third parties you are reliant on and what are their key assumptions/features of their models?
  • What is my firm best and worst at modelling and how will we level up our capability?
  • Going forward what are the key assumptions your institution is making about the trajectory of climate policy and physical risk and its impact?
  • If other banks are expecting to carry out the same strategic changes to their businesses that you are, would your planned response to climate risk still be a workable/sensible one?

Harshil Patel