Bank of England report on climate-related risks and the regulatory capital frameworks

The Prudential Regulation Authority (PRA) has published a new report entitled climate-related risks and the regulatory capital frameworks. The report provides an update on the activities and findings since the last publication of a similar report in 2021, the so-called Climate Change Adaptation Report 2021. The 2021 outlined the then current framework for capturing climate-related risks in the banking and insurance sector, including the assessment of these risks via indirect risk measures such as credit or litigation risks. As the entire topic was / is still evolving, the PRA back then committed to do more work in this context to specifically identify areas where improvements are needed. This report now summarizes the PRA’s activities since then and some key findings and outlines also areas where more work is needed. Each issue is briefly summarized below.
#### Activities since then:
– The PRA conducted the 2021 Climate Biennial Exploratory Scenario (CBES) to determine the level and scope of exposure of UK banks and insurance undertakings to climate change risks.
– In 2022, the PRA sent out a „Dear CEO Letter“ describing „thematic observations on firms’ levels of embeddedness“ as regards climate change-related risks.
– Also in 2022, the PRA launched a „Call for Research“ to get feedback from various stakeholders on issues surrounding the integration of climate change-related risks into the risk management practices of supervised entities.
– In October 2022, the Bank of England hosted a conference entitled „Climate and Capital“, again bringing together various stakeholders to discuss „conceptual issues further“.
#### Key findings since 2021:
The PRA notes that due to the uncertainty surrounding climate change in terms of the scope of the change and the impacts upon firms, the PRA will primarily concentrate on enhancing the capabilities of supervised firms to capture climate change risks and adopt adequate risk management strategies. Furthermore, the PRA will continue to explore the capital needs of supervised institutions for effective climate change risk management and the embedding of these risks in the capital framework of supervised entities. So far, so the PRA, the findings suggest that „Effective risk-management controls within firms can reduce the quantum of capital required in the future for resilience, but the absence of controls might suggest a greater quantum of capital will be required“.
Furthermore, the PRA has learned that – to facilitate effective climate change risk management – a more forward-looking approach is needed. Current scenario analysis for other types of risks (credit risk, market risk) are rather „short-term“ in nature compared to the effects of climate change. Therefore, the PRA will need to develop adequate stress testing frameworks to reflect this forward-looking approach.
#### More work is needed:
In view of the above noted findings, the PRA has identified several areas where more work is needed to adequately address climate change-related risks in the risk management practices of supervised firms and identify the capital requirements of insurance undertakings and banks. The key questions arising in this context are briefly noted in below table. Also in this context, the PRA notes that it would welcome any evidence on those questions. Submissions may be made to the following e-mail address: ClimateCapital@bankofengland.co.uk.
Table 1 – Key Questions That Need To Be Addressed