The regulator warned the ’uncertainty represents a risk appetite challenge for micro and macroprudential regulators’

The Bank of England (BoE) has warned there is “uncertainty” around whether insurers and banks are adequality capitalised against the threat of climate risks.

The central bank set out its latest thinking on climate related risks and regulatory capital frameworks in a report published this week (13 March 2023).

This came following the publication of its Climate Change Adaptation Report in October 2021, which said said that the current frameworks already captured climate risks to some extent.

However, the BoE warned in its new report that risk capture may be incomplete due to difficulties estimating risks from climate change.

“Existing capability and regime gaps create uncertainty over whether banks and insurers are sufficiently capitalised for future climate related losses,” it said.

“This uncertainty represents a risk appetite challenge for micro and macroprudential regulators.”

The report warned regulators, including the Bank, that it needed to form judgements on whether quantified and unquantified risks were within “risk appetite and act accordingly”.

It added that effective risk management controls within Prudential Regulation Authority (PRA) regulated firms could reduce the quantum of capital required in the future for resilience, but the absence of controls might suggest a greater quantum of capital would be required.

Short term progress

The BoE said the PRA expected firms to develop and embed effective risk management processes to manage their climate risks.

As a short term priority, the Bank said it was focused on ensuring firms made progress to address capability gaps to improve their identification, measurement and management of climate risks.

“Further progress by firms to address capability gaps is important in the short term to provide a better foundation for the identification, measurement and management of climate risks,” the report said.

“This will provide a better basis for identification of material regime gaps that need to be addressed and for the design and calibration of capital tools.

“Therefore, the Bank’s view is that addressing capability gaps is an important short term priority.”

The BoE added it would continue to develop its strategy and capabilities to use climate scenario exercises to understand firms’ exposures to climate risks and drive further improvements in risk management.

On balance, however, it did not think that the arguments for changing the time horizons for regulatory capital setting were supported at this point.

”The Bank will continue to explore how climate risks can be calibrated within the timelines embedded in existing capital frameworks,” the report added.