BoE test suggests ‘absorbable’ net-zero transition for banks and insurers | New

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UK banks and insurance companies can tolerate a move to net-zero emissions by 2050, according to the Bank of England’s (BoE) first two-year exploratory climate scenario (CBES) released this week. However, they would see an annual reduction in benefits amounting to 10-15% if averaged over three climate policy scenarios.

“Based on this exercise, the costs of a transition to net zero appear absorbable for banks and insurers, with no worrying direct impact on their solvency,” said Sam Woods, chief executive of the Prudential Regulatory Authority. of the Bank, drawing attention to the compensatory measures available. to the sector.

For example, the BoE noted that insurance companies would be able to weather the stress as less than 5% of losses fall on shareholders. The rest would accrue to policyholders in the form of higher insurance premiums.

Nonetheless, he also noted a steady upward trend in climate-related litigation affecting insurance companies, and the potential for professionals to be drawn into many different types of litigation.

Meanwhile, banks could protect their capital position by cutting profits, cutting dividends and charging higher interest to borrowers in carbon-intensive industries, for example.

To perform the CBES – dubbed the climate stress test – the BoE used two optimistic and one pessimistic scenarios.

The Early Action (EA) scenario envisions ambitious climate policy from the outset, while the Late Action (LA) scenario envisions a 10-year timeframe for net-zero transition policies. In both scenarios, global warming reaches 1.8°C by 2050 compared to pre-industrial levels. They contrast with a severe scenario involving no further action (ANA), where global warming increases by 3.3°C by 2050.

To comply with the CESB, the 18 participating financial institutions applied their balance sheets as they stood at the end of 2020 to the three different scenarios.

Banks, for example, have modeled the effects on their loan portfolios. The industries in which they predicted the highest loss rates in both transition scenarios were mining, oil and gas, manufacturing, transportation, and wholesale and retail trade.

According to the banks’ projections, these sectors would have cumulative depreciation rates of 35%, more than double the overall depreciation rate projected on corporate portfolios.

“It will be in the collective interest of financial institutions to support counterparties that have credible adaptation plans”

Sam Woods, CEO of the Prudential Regulation Authority

The economic effects vary depending on the scenario. For example, banks in the LA scenario would suffer loan loss rates equivalent to £110 billion (€129.5 billion), more than double the losses in the EA scenario. In the LA scenario, unemployment in the UK rises to 8.5% and the economy goes into recession for a short time.

In the ANA scenario, UK and global GDP growth is permanently weaker and macroeconomic uncertainty increases. UK share prices are down just under 20%. The value of insurers’ assets fell by 15% in ANA scenario, compared to 8% and 11% in the EA and LA action scenarios, respectively.

UK banks and insurers are generally expected to respond to the scenarios in this exercise by following their existing net zero emissions plans, including increasing counterparty engagement to support the transition.

“It will be in the collective interest of financial institutions to support counterparties who have credible plans to adapt and ultimately reduce their exposures to sectors of the economy that are not compatible with a net zero policy,” Woods said.

He also drew attention to uncertainties in the projections and warned that losses would make these sectors more vulnerable to other future shocks.

“The drag on profitability would be very unpleasant for companies, but as long as they are able to continue to earn sufficient profits to maintain their capital reserves, its impact on safety and soundness could be less significant,” said he declared.

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