The Bank of England will introduce climate stress tests, to establish whether banks and insurance companies are capable of withstanding environmental shocks.
The Bank of England will be the first central bank ever to verify whether the financial system is capable of withstanding the risks posed by climate change. This means that large banks and insurance companies will have to subject their assets to specific climate stress tests, following the model of the "classic" ones that concern capital soundness.
After the global financial crisis of 2007–2008, symbolised by the collapse of the American investment bank Lehman Brothers, the authorities regulating international finance were forced to take remedial action, in order to regain the confidence of markets and citizens and to prevent a trauma of that kind from happening again. Both the US Federal Reserve and the European Banking Authority therefore introduced stress tests.
Since then, the balance sheets of major banks have been put under the microscope at regular intervals, to establish whether they are solid enough to remain standing even when external circumstances prove unfavourable. In Europe these checks are carried out every two years. The most recent ones date back to the end of 2018 and scrutinised the data of 48 credit institutions, hypothesising a baseline scenario and an adverse scenario characterised by a public debt crisis, an economic recession and so on.
This is the starting model. One that, however, many argue risks proving inevitably partial. Climate change, which increasingly manifests itself in the form of extreme weather events, causes colossal economic losses, triggers humanitarian emergencies, and brings about forced migrations on a vast scale. In short, a destabilised climate is, in every sense, a risk factor for the resilience of our financial system. And it has been ignored for far too long.
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This is where the Bank of England's ambitious new plan comes in, as described by the newspaper The Independent. The balance sheets of the largest banks and insurance companies will be examined against three different scenarios, this time not economic but climatic. In the first, the Guardian explains, authorities undertake an effective and timely transition to a zero-emissions economy, managing to keep the rise in average global temperatures within 2 degrees centigrade above pre-industrial levels. In the second scenario this process takes place and achieves its objectives, but with a ten-year delay. The most pessimistic hypothesis envisages total failure: governments do not tackle the climate emergency, citizens and businesses do not adjust their behaviour, and global temperatures rise by 4 degrees by 2080, with all the consequences that entails for land, economic activity and people's lives.
The Bank of England is currently fine-tuning the climate stress tests. The roadmap envisages releasing all the details in the second half of next year and officially launching them in 2021. If financial institutions fail them, they will likely be required to take appropriate countermeasures, such as increasing their capital reserves or divesting certain assets.
According to Bank of England governor Mark Carney, the new system will be "a pioneering exercise that further develops the considerable progress already made by companies, central banks and regulators in addressing climate-related risks". Climate change, he added, "will virtually have an impact on the value of any asset. The tests will ensure that the core of our financial system is resilient in the face of these changes."
