UK banks and insurers urged to boost climate accounting practices

UK banks and insurers should improve their climate reporting process, the UK Prudential Regulation Authority (PRA) said in a letter to the Bank of England (BoE). 

In the letter sent on 29 September, the regulator called upon banks and insurers to “establish transparent plans and deadlines for the development of climate accounting capabilities,” reminding them of the need to assess and handle climate-related risks.

The PRA noted that not all companies have met its expectations, including the ambition to create plans for climate accounting capabilities and establish management information for overseeing implementation. 

The advice comes after an annual audit of the UK’s largest banks and insurers, with this year’s questions focussed on international financial reporting standard (IFRS) 9 expected credit loss accounting and climate-related financial risks. IFRS 9 specifies how an entity should classify and measure financial assets and liabilities. Nine firms fell within the audit, which included questions to auditors about how companies quantify the impact of climate risks on expected credit losses during financially stressful periods.

The PRA’s letter identified early action areas to improve practices and other areas where progress might take more time. For instance, it found that determining the right metrics to identify loan portfolios and segments most vulnerable to climate risks remains a challenge. It also observed that auditors considered various potential risk factors when firms did not provide adequate analysis.

The report highlighted the importance of adopting improved practices, such as creating standardised ESG scores with client-level data for assessing loans in higher-risk sectors and enhancing quantitative analysis. It also recommended strengthening in-house scenario analysis and utilising customer-level data to identify vulnerabilities in specific sectors or products.

“Availability and quality of data remain pervasive challenges,” the letter highlighted. The regulator recommended centralising climate risk data under overarching data quality frameworks. These repositories would cover the necessary data to factor climate risks into balance sheet valuations and enhance control over new data sources used in financial reporting.

The PRA reiterated previous expectations, emphasising the need for banks and insurers to understand and disclose the financial risks associated with climate change. This should involve scenario analysis and stress testing to identify and disclose short- and long-term climate-related financial risks, the PRA said.

The findings and recommendations echo reports that warn of a climate insurance protection gap. A landmark report from the Institute and Faculty of Actuaries and the University of Exeter earlier this year found current climate change scenarios are “wildly missing or under estimating potential risk”. Meanwhile academics claim there is a “high likelihood” that the net zero transition will lead to a buildup of prudential risk by 2050.