Submission to the PRA Consultation CP10/25 — Enhancing banks’ and insurers’ approaches to managing climate-related risks — Update to SS3/19

This report consists of a submission by CETEx made in response to the open consultation by the Bank of England CP10/25 — Enhancing banks’ and insurers’ approaches to managing climate-related risks — Update to SS3/19. The consultation paper sets out the Prudential Regulatory Authority’s (PRA) proposals on updated supervisory expectations for banks and insurers. The proposals would help banks and insurers manage the effects of climate change on their businesses, and thereby maintain the essential services they provide to the economy.

This consultation response offers several avenues to refine the proposed PRA approach, drawing on research across the LSE’s Grantham Research Institute on Climate Change and the Environment.

Key messages

The authors address the following key points in relation to supervision of banks’ approaches to managing climate-related risks in particular:

• A resilient financial sector can support the process of adjustment to the transition in a way that accelerates growth, competition and the net zero transition globally. So far banks continue to underestimate the climate change-related risks and investment opportunities in the transition.
• While a dedicated guidance on climate change risks supports the enhancement of banks’ approaches, climate change factors are drivers of existing prudential risk categories (credit, market and operational risk). Assessing how banks integrate climate change risk factors into their business models and risk management should be consistently integrated across supervisory review and evaluation processes.
• Proportionality in integrating climate change factors in prudential regulation and supervision should not rely solely on banks’ self-assessment of materiality of climate change factors. Supervisors should likewise calibrate their approach depending on the risk profile of the supervised firm and be ready to question banks’ assumptions, especially in cases of high concentrations of climate change risk exposures in sectoral or geographic terms.
• Supervisory expectations are an important tool for prudential authorities to enhance the state of banks’ climate-related risk management. In addition to formal guidance, supervisors may use other soft tools such as collaborations with industry and academia. Credible supervisory guidance should be accompanied by enforcement actions.
• In relation to the PRA’s proposals, drawing on existing CETEx research, the following suggestions are put forward:
  • Scope: The Supervisory Statement should explicitly address nature-related risks. These not only amplify climate risks but also pose distinct threats such as soil degradation, water and air pollution, and pollinator decline that may fall outside the scope of climate-only risk assessments. A joint climate change and nature-related risk approach will help ensure financial institutions fully understand, assess, and mitigate the breadth of environmental risks and avoid underestimating their exposure.
  • Governance: The PRA principles rightly elevate the importance of board ownership over the process of integration of climate change factors in business model and risk management at the strategic level. The proposals could be further reinforced to ensure adequate capacities at board level and across the organisation.
  • Risk management: The Bank of England should provide further details on how risk identification (e.g. via climate scenario analysis) should inform risk mitigation by banks. In this regard, the Bank could consider bank transition planning as a risk management tool.
  • Climate scenario analysis (CSA): The Supervisory Statement should provide further guidance on the deployment and transparency related to CSA (e.g. requiring firms to document related decision-making, incorporate national climate goals, disclose which material risks are covered or not, use long-term time horizons). Banks should be required to clearly articulate how CSA is guiding their risk mitigation actions and integrated in their governance.
  • Disclosures: The PRA should consider introducing the Basel Committee on Banking Supervision’s (BCBS) voluntary framework for the disclosure of climate-related financial risks to support global interoperability of physical and transition risk metrics in bank risk management.