Four key takeaways from the BoE’s climate and capital conference

The Bank of England (BoE) hosted a landmark climate and capital conference last week, bringing together central bankers, financial regulators, industry experts and academics to consider issues associated with adjusting the UK’s capital framework to account for climate-related financial risks.

BoE officials gave an update on their plans to publish new guidance, and attendees expressed support for capital changes at a macroprudential level. Here are details on these developments, plus more key takeaways. For full coverage read the live blogs from day one and day two.

BoE has an ‘open mind’, but timeline for new guidance uncertain

BoE deputy governor Sam Woods and climate lead Sarah Breeden stressed that the bank has a “completely open mind” on whether and how it will integrate climate considerations into its capital framework. Woods confirmed the bank will publish an update on its thinking “in due course”. His remark appears to cast doubt on a commitment the bank and Prudential Regulation Authority (PRA) previously made to publish new guidance by the end of 2022.

Woods said the BoE is keen to contribute to international standards on climate and capital, and expressed hope that the conference would inform debate elsewhere. The bank says it is participating in the discussions currently underway at the Basel Committee on Banking Supervision, the Task Force on Climate-related Financial Risks, and at the International Association of Insurance Supervisors.

New evidence of climate risk link to mortgages

The conference heard about research demonstrating the presence of a risk differential between greener and dirtier assets in the mortgage sector. Ben Guin, a senior economist on prudential policy at the BoE, presented the findings of a survey of properties’ energy performance certificates (EPC) and credit risk, which showed the rate of arrears to be 18% lower among mortgages on energy efficient homes.

However, Guin suggested that the EPC data is not yet sufficiently comprehensive to use in setting capital requirements. He said capital requirements need consistent data over time, whereas EPCs have changed and evolved.

Zsolt Jaczko, head of retail IRB modelling at Nationwide Building Society, also presented research on a link between the energy efficiency of houses and mortgage default rates. He and his colleagues similarly found that the owners of high and medium-energy-efficient properties seem to be less likely to default than those with low-energy-efficient properties, controlling for factors such as borrower income.

The two presentations were notable in identifying an apparent climate risk differential using backward-looking data, a phenomenon which has proved elusive in the past. A paper by the Network for Greening the Financial System (NGFS) said there was little proof that climate risk differentials exist. The NGFS has suggested that forward-looking methodologies are better suited to assess the distinct features of climate-related risks – a point that was repeated by several participants at the BoE conference.

Support for capital changes at macroprudential level

Pierre Monnin from the Council of Economic Policies made the case for the use of systemic risk buffers and concentration limits as part of a holistic approach towards addressing climate risk using all elements of central banks’ prudential toolkits.

He said regulators could start by focusing on the largest institutions or the institutions that are most at risk, perhaps using a sandboxing approach whereby they implement some limited measures, improving and extending them as they gain more experience.

Monnin argued that the distinct nature of climate risks mean central banks and supervisors must therefore go out of their comfort zone and act quickly, even if they have only partial and incomplete data on how risks may materialise. He rejected suggestions that climate-focused concentration limits would necessarily have a disproportionate effect on smaller banks with more concentrated business models or geographies, suggesting they could be applied first to large institutions which are more systemically important.

In a poll of participants at the conference, 93 of 182 respondents said both micro and macroprudential elements are most appropriate to reflect the risk from climate change in the capital framework, while a further 19 selected just macroprudential elements. In addition, 34 said it was too early to tell, 31 opted for microprudential firm-specific elements, and just five opted for neither microprudential nor macroprudential tools.

Mobilise all available levers in support of green transition, policymakers urged

Although speakers from the BoE were clear they do not regard capital requirements as an appropriate tool to address the causes of climate change, the conference heard several contributions calling for greater alignment of central bank frameworks with government fiscal measures.

Monnin argued that although a carbon pricing framework is the first step to bring about the green transition and falls outside of the responsibility of central banks, macroprudential tools such as the systemic risk buffer can be used in parallel with fiscal policies in order to leverage them. He said central banks can help deliver a complementary approach to deliver the transition needed.

Frank van Lerven, an economist at the New Economics Foundation, noted that private sector green investment is stagnating, despite the UK’s Climate Change Committee projecting that the country will need to mobilise £50bn per year by 2030. He said adjusting banks’ capital is not going to solve this alone but there is a need to ensure “every part of the system is moving in the same direction”.

Nicola Ranger, director of climate and environmental analytics at the UK Centre for Greening Finance and Investment, struck a similar note, arguing that policymakers should be evaluating the financial stability risks involved in levers being pulled in different directions at the same time.

In a separate session, Nick Robins, who leads research on sustainable finance at the LSE Grantham Institute, gave a nod to the double materiality principle, arguing that misalignment of financial institutions with net zero is itself a reasonable cause for regulators to take action.