The Bank of England has told banks and insurers it is prepared to use its powers to crack down on them if they fail to manage climate risks.
The warning came as the central bank begins to review a potential introduction of capital requirements linked to unsustainable assets.
The Bank said on Thursday it would take a more active approach to the climate crisis in the new year when City firms would have to demonstrate a good understanding and management of the related financial risks. Those lagging behind would face action by its regulatory arm, it said.
In a climate adaptation report released on Thursday the Bank’s Prudential Regulation Authority (PRA) said such action could include ordering a “skilled persons” review of offending firms that could lead to a “deep-dive audit” or additional monitoring.
The regulator said it also had the powers to impose additional capital requirements linked to assets carrying climate risks.
Capital requirements determine the kind of financial cushions banks must have to protect them from risky loans and products on their balance sheets. They can act as a deterrent, since capital rules make risky assets more expensive to hold.
“Where progress is insufficient and assurance or remediation is needed the PRA will request clear plans and, where appropriate, consider exercise of its powers,” the Bank of England said.
Climate campaigners at Positive Money welcomed the announcement, saying capital requirements could help reduce the amount of funding provided to polluting firms.
“After months of pushing back on the idea of ensuring capital rules reflect climate risk, believing that banks can be left to themselves to address this systemic issue, it is positive that the Bank of England appears to be recognising the need for stronger regulation,” said David Barmes , Positive Money’s senior economist. “Such reforms are long overdue and policymakers should move to implement them without delay.”
However, the Bank signalled that it was unlikely to deploy capital rules until it had conducted a further review, in 2022, on use of the rules, which would also allow it to complete its first climate stress tests involving the UK’s largest banks.
The Bank explained that the complex nature of climate forecasts and transition paths, which stretch over decades, made it harder to assess the value of climate risks. “Accordingly, research and analysis on sizing climate-related financial risks for capital purposes is nascent and not always conclusive,” it said.
The regulator also said that capital requirements were likely to target the consequences rather than the causes of climate change. That could mean the setting of capital requirements would be based on the effects of government climate policies, rather than on those assets being linked to higher carbon emissions.
Banks, for example, may have to hold capital against loans to petrol vehicle manufacturers owing to the fact that the UK plans to ban the sale of such vehicles by 2030. It is less likely that the regulator would require banks to hold capital against loans made to fossil fuel producers, unless it were part of the government’s transition plan.
The PRA has already begun an initial review into the use of capital requirements to protect against climate risks, but will be calling for further research and will hold a conference on the issue in 2022 before issuing guidance.