On 26 September 2018, the Prudential Regulation Authority (PRA) published a report on the impact of climate change on the UK banking sector (the Report).
The Report examines the financial risks from climate change that impact PRA regulated banks, building societies and designated investment firms, and assesses how banks are responding to and managing the financial risks from climate change.
The Report notes that two channels of risk emerge from climate change:
- physical risks: arising from climate and weather-related events. These risks can potentially result in large financial losses, impairing asset values and the creditworthiness of borrowers; and
- transitional risks: arising from the process of adjustment towards a low-carbon economy. Changes in policy and technology could prompt a reassessment of the value of a range of assets and create credit exposures for banks and other lenders as costs and opportunities become apparent.
Within these risk channels lie further risks, namely:
- credit risks: failing to adequately prepare for the immediate threats posed by the risk channels can lead to increased credit exposure for banks;
- market risks: physical risks creating macroeconomic changes, coupled with the impact of a low-carbon economy on business could have a notable impact on carbon-intensive industries e.g. commodities and derivatives trading; and
- operational risks: weather events can impact a businesses’ continuity and infrastructure. Transitional risks include the reputational hazard to banks not adequately transitioning to low-carbon processes.
The Report concludes that financial risks arising from climate change are sufficiently material to be considered at board level and that the current approach to risk management varies widely between banks. The PRA will thus set out for consultation its supervisory expectation for banks shortly, whilst also establishing the Climate Financial Risk Forum to help identify and address shared challenges within the financial sector.