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Big Banks Face Climate-Change Tests – The Wall Street Journal

The Bank of England launched a program to assess the ability of lenders and insurers to withstand risks such as rising sea levels, flooding, cyclones and wildfires, in the latest step by a central bank to scrutinize the impact of climate change.

The U.K.’s biggest banks, including HSBC Holdings PLC and Barclays PLC, and insurers such as the U.K. units of American International Group Inc. and parts of Lloyd’s of London, will estimate how their businesses will perform in the next 30 years based on three different scenarios in which governments and companies either take early, late or no action to mitigate climate change.

The tests represent the latest step by central banks and financial regulators to look at climate change when assessing the health of financial institutions. Regulators have traditionally used similar “stress tests” to measure the resilience of lenders to adverse economic scenarios such as deep recessions, rises in interest rates or trade wars.

Many central bankers now see climate change as part of that mix, potentially leading to loan losses or higher inflation because of supply disruptions. Rising sea levels can endanger the value of an asset, such as a hotel, that is collateral for a loan. Floods caused by climate change can disrupt supply chains, leading to losses on loans and investments to corporations.

The Bank of England’s program will see lenders model the impact of climate change on loan losses and insurers, to assess how the value of assets and liabilities will change.

Under the central bank’s first scenario, governments and companies take action this year to reduce carbon-dioxide emissions to net-zero by 2050, limiting global warming to a 1.8 degrees Celsius temperature rise relative to preindustrial levels.

Under its second scenario, policy action is delayed until 2031 and the transition from a fossil-fuel dependent economy to the widespread use of renewable energy is “more sudden and disorderly.”

Under the third scenario, no action is taken to mitigate climate change beyond the steps already taken, and increased greenhouse-gas emissions in the atmosphere cause temperature levels to rise by 3.3 degrees Celsius.

The Bank of England’s most extreme scenario sees “chronic changes in precipitation, ecosystems and sea-level,” as well as an increase in the frequency and severity of extreme weather including heat waves, droughts, wildfires, tropical cyclones and flooding. Both U.K. and global economic growth is permanently lower in this scenario.

Satellite data indicate wildfires are becoming bigger and more intense. WSJ talks with NASA’s Doug Morton to understand what is making the planet more flammable and fires harder to control. (Originally published Dec. 9, 2020)

The central bank plans to publish aggregated results of the climate test by May, but won’t detail results for individual institutions. Unlike traditional stress tests, it won’t use the climate test to set capital requirements for banks.

The test will require banks and insurers to request additional information from their clients to assess the climate risks, Bank of England Gov. Andrew Bailey said.

The climate test is based on scenarios developed by the Central Banks and Supervisors Network for Greening the Financial System, a Paris-based group of more than 90 central banks and regulators including the Federal Reserve, the European Central Bank and the People’s Bank of China.

More than a dozen central banks and regulators are working on or planning climate tests, according to central bankers involved with the matter. A pilot climate test by the Bank of France found that the cost of insurance claims could rise as much as six times in parts of France by 2050 because of the increasing risk of droughts and flooding.

At an online conference last week, Federal Reserve Chairman Jerome Powell said climate change was a major long-term challenge for the world economy.

“There’s no doubt that climate change poses profound challenges for the global economy, and increases uncertainty for the financial system,” Mr. Powell said Friday. “Significant challenges lie ahead for all of us.”

Write to Simon Clark at simon.clark@wsj.com

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