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(Alliance News) - The Bank of England said Tuesday it will look into the financial risks posed by climate change for the largest UK banks and insurers.
"The Climate Biennial Exploratory Scenario is an exploratory exercise," the central bank said. "It will not be used by the bank to set capital requirements. Instead, participants' submissions may inform the Financial Policy Committee's future approach to system-wide policy issues, and the Prudential Regulation Authority's future supervisory approach."
The first-ever climate stress test will scrutinise the resilience of the UK's biggest banks and insurers against climate change risks over the next 30 years.
"The CBES uses three scenarios of early, late and no additional action to explore the two key risks from climate change: the risks arising from the significant structural changes to the economy needed to achieve net zero emissions - 'transition risk' and risks associated with higher global temperatures - 'physical risks'," the BoE explained.
The UK's seven biggest lenders will take part, including Lloyds Banking Group PLC, Barclays PLC, NatWest Group PLC and Nationwide Building Society.
Insurance giants including Aviva PLC, AXA SA, Direct Line Insurance Group PLC, RSA Insurance PLC and Legal & General Group PLC will also be part of the test.
The BoE added: "The bank intends the CBES to be a learning exercise. Experience and expertise in modelling climate-related risks is still relatively immature, so this exercise will develop the capabilities of both the bank and the CBES participants."
The central bank said the test will be carried out every other year, unlike its regular annual stress tests, and will not be used to set how much cash banks need to set aside on their balance sheets as a cushion against risks.
The bank will publish the results of the test in May next year.
Andrew Bailey, governor of the Bank of England, said: "Today's exercise will help us size the risks from climate change for both the largest banks and insurers as well as the financial system as a whole."
"The end result will be more robust management of climate-related financial risks across the sector," he added.
The test will look at gauging the size of risks to bank credit books and to the assets and liabilities of insurers.
While it will not be used to determine capital requirements, the bank said the test will help it better model climate-related risks and inform future regulation.
Sarah Breedon, the bank's executive sponsor for climate change, said: "Though fiendishly complicated, climate scenario analysis is a critical part of our toolkit to address future uncertainty about what might happen to our planet, our economy and our financial system.
"Some scenarios show the most efficient pathway to net zero while others highlight the risks of late or insufficient action. By highlighting the risks of tomorrow, they can help guide actions today. I encourage all firms, not just those participating, to engage in and learn from this exercise."
By Paul McGowan; paulmcgowan@alliancenews.com
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