Economies shrinking, sea levels rising: How will banks and insurers cope with climate change?

The Bank of England is to test how big banks and insurers can cope with the risk of rising sea levels, more frequent heatwaves and shrinking economic output caused by climate change.

It has published three stress test scenarios to explore what might happen if fresh action is either taken quickly to tackle global warming, delayed for a decade or not taken at all.

In the last case, with no new climate policies being implemented and a growing concentration of greenhouse gases, temperatures are projected to rise to 3.3C above pre-industrial levels.

Image: The Bank said it was the first test of its kind

Under such a scenario there would be “chronic changes in precipitation, ecosystems and sea level” and “a rise in the frequency and severity of extreme weather events such as heatwaves, droughts, wildfires, tropical cyclones and flooding”.

“There are permanent impacts on living and working conditions, buildings and infrastructure,” the Bank said of this scenario.

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“UK and global GDP growth is permanently lower and macroeconomic uncertainty increases.”

Tropical and subtropical parts of the world would be affected more severely and the impacts would worsen later in the century, with some becoming irreversible “so the headwinds facing the economy would be expected to increase further into the future”, the Bank said.

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In the UK, average winter rain and snow fall would increase by 25% and sea levels rise by 0.4m – threatening coastal flooding – compared to the late twentieth century.

In contrast, the “early action” scenario with carbon taxes and other policies intensifying “relatively gradually” sees carbon dioxide emissions reduced to net zero by 2050 and the rise in temperatures limited to 1.8C.

Image: More frequent flooding could be one consequence of not taking action on climate change,

Some sectors would be worse affected than others by the transition but the overall impact on GDP is muted, the Bank said.

“Late action” delayed until 2031 could see climate policies achieve the same goals by 2050 but because emissions are reduced over a shorter timescale, would mean greater economic disruption – resulting in sharp UK and global economic contraction, job losses and market turbulence.

Results of the test will be published by May next year.

It will examine lenders Barclays, HSBC, Lloyds, Nationwide, NatWest, Santander UK and Standard Chartered as well as insurers including Aviva, Legal & General, Direct Line, and Scottish Widows.

The aim of the test is to bring to light currently little-known risks to the balance sheets of the companies involved and what action they and the Bank may need to take.

“This is the first time we are testing both banks and insurers to allow us to capture interactions between them andunderstand the risks presented by climate change across the financial system,” the Bank said.

Image: Activists have protested over the Bank’s climate change stance

It is an “exploratory exercise” which will not be used – as other Bank of England stress tests are – to set requirements on how much capital financial firms must hold as a precaution against risks.

Bank governor Andrew Bailey 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.”

Sarah Breeden, 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.”

Last week, Mr Bailey warned that the risks posed by climate change were not reflected in the market prices of most financial assets.

Campaigners have previously targeted the Bank claiming it is not doing enough to tackle the issue.