How central banks are assessing the impact of climate risk for financial services

Bank of England spearheads climate risk analysis

The momentum began in 2019, when the Bank of England issued a supervisory statement on the need for banks to incorporate climate risks into their risk framework.

That same year, through the Prudential Regulation Authority, it released a framework on assessing the financial impacts of physical climate change for the insurance sector. The framework was created by an industry-wide working group with representatives from across the general insurance market, including 3 of our experts. It was designed as a way for practitioners to assess climate risk using available tools, and to be a possible starting point for assessing the impact of climate exposure in the context of business decisions and disclosure requirements.

Our natural hazard data (supplied under what was then our Ambiental brand) was also used to develop case studies illustrating how the framework can inform insurers’ risk management decisions. Our flood intelligence was used to show the impact of flooding on a sample property portfolio for 3 different 2050 scenarios: low emissions, medium emissions and high emissions. Since the report was published, insurance and reinsurance companies have used the framework and methodologies to inform their climate risk assessment approach.

In 2021, the Bank of England released the results of its Climate Biennial Exploratory Scenario (CBES), an 18-month analysis of the financial risks posed by climate change for the largest UK banks and insurers. It concluded that “climate risks are likely to create a drag on profitability”, and while “UK banks and insurers are making good progress in some aspects of their climate risk management…[they] still need to do much more to understand and manage their exposure to climate risks.”

European Central Bank conducts in-depth climate risk stress testing
In 2022, the ECB launched the first climate risk stress test for European banks. The results showed that banks face huge potential projected risk under the short-term scenarios covering transition and physical risks. Flood, drought and heat events were identified as key climate hazards for the sector.

The report showed that European banks face a potential €70 billion hit from increasing natural disasters and large-scale changes across industries in the wake of an economic downturn and other global challenges.

Climate risk intelligence is key to mitigating impact
The CBES found that a key barrier to making progress was that banks and insurers lacked climate hazard data to inform planning. Likewise, the ECB’s stress testing exercise revealed many “deficiencies, data gaps and inconsistencies across institutions” – with the report stating that the ECB “expects banks to make substantial further progress in the coming years.”

Twinn climate risk intelligence is helping banks and insurers plug those gaps by providing risk scores for any location based on 19 natural hazards. It leverages machine learning and exposure analysis to provide clarity on climate risks affecting global operations now and for various future scenarios following the Representative Concentration Pathways (RCPs) and Shared Socioeconomic Pathways (SSPs) in accordance with the latest projections from the Intergovernmental Panel on Climate Change (IPCC).