Live – BoE climate and capital conference: open minds but plenty of work ahead

October 20, 2022|Written by Graham Caswell

The final session of the Bank of England’s climate and capital conference brought together moderators of earlier panels to look towards the future and possible next steps,

Chaired by Sarah Breeden, executive director of financial stability, strategy and risk at the Bank of England (BoE), she began by listing the three core issues facing the conference: the nature and time horizons of potential interventions to reflect climate risk in regulatory frameworks, as well as managing the uncertainties involved. These are interlinked, she said, giving an example of how the type of capital requirement and the implementation period would affect uncertainty. Other important issues and questions she identified included materiality, the building of risk management capabilities in financial firms, the use of non-capital tools to capture risk, and the ability of institutions to act within their mandates.

“It’s clear that there is a huge amount of interest in this topic,” Breeden said, thanking those who submitted papers to the conference for their “fascinating” and important input.

Vicky Saporta, executive director of prudential policy at the BoE and chair of the executive committee of the International Association of Insurance Supervisors, was the first to offer her reflections on the conference. She praised the paper introducing a stylised capital framework presented by Kevin Stiroh of the Federal Reserve, focusing particularly on the assumptions and beliefs identified by Stiroh as necessary for each of the elements.

Summarising her own presentation, Saporta reiterated that climate risk affects both sides of insurer’s balance sheets, while affecting only one side of bank balance sheets. The subsequent discussion showed agreement that lack of action would mean that both mean losses and the variance or volatility of losses would increase, she said. Saporta also pointed to interlinkages between the climate risk facing banks and insurers, saying that loss of insurance coverage as a result of climate risk had implications for banks as well.

Next up was Alison Scott, director of supervisory risk at the Prudential Regulation Authority, discussing where interventions in the banking prudential framework might happen. Starting with the microprudential, she reviewed UK evidence of a risk differential between green and carbon intensive mortgages, using property energy efficiency as an indicator. However, this differential hasn’t been seen in corporate lending, she said.

Turning to the macro side, Scott reviewed an analysis from the European Central Bank suggesting that climate risk would manifest first as market risk, followed by credit risk. There was a consensus among the panel of her earlier session that a combination of micro and macro prudential action was required, she said. Scott also emphasised the need for further and forward-looking research.

Julia Black, an external member of the BoE’s prudential regulation committee, then reviewed the discussion on time horizons. One conclusion was that climate risk is a chronic one-off risk which is not cyclical but irreversible, she said, and that it is going to happen with no return to the status quo. Turning to the time scale, Black gave the results of an audience poll suggesting that 3-5 years and 5-10 years are seen as appropriate time horizons by the majority of participants.

Jo Paisley, president of the Global Association of Risk Professional’s Risk Institute, then reviewed her panel’s discussion on the uncertainties involved. There was a feeling that short term uncertainty is an issue as well as long term uncertainty, she said, with policy uncertainty being one of the biggest unknowns at the moment. She noted that there is also uncertainty regarding technology development and the amplification of climate-related shocks.

Paisley then turned to scenarios, saying that while there was a consensus they were the right tool, there are also significant issues with the scenarios being used, with more focus on disorderly and “hothouse” scenarios needed. She also said the narratives underlying the scenarios were important.

Breeden then turned the discussion to working out where regulators are and what to do next, offering a “summary of the summaries” before asking for general comments and reflections. Scott replied, saying  the sector should stop looking at a smooth transition and start focusing on disorderly scenarios. “We should stop kidding ourselves a bit,” she said, calling also for a public dialogue to prepare people and firms for coming changes. Black said she wanted to see  movement towards a dynamic balance sheet model to capture anticipated changes in market behaviour and for clear and understandable transition plans.

Wrapping up the session, Breeden thanked the participants and said that this is just the start of the debate. “We have an open mind”, she said, and that there is a huge amount of work to be done.

This page was last updated October 20, 2022

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