The climate crisis has pushed the Bank of England to consider stringent new tests for lenders to see how they would cope in an “extreme” catastrophe that plunges “Westminster under water” and sparks a rapid change in government policies.
Sam Woods, the boss of the UK’s financial stability watchdog, suggested that the City needed to be put through a more rigorous scenario, having so far only proven that banks and insurers could survive “slow burn” changes over a span of 30 years.
Woods, who runs the Bank’s Prudential Regulation Authority (PRA), said he is waiting for an opportunity to test the City’s resilience against a “very large climate event” that knocks out a major financial hub such as London, Paris or New York, and sends shockwaves through global markets. His watchdog, part of the Bank of England, was set up in the wake of the 2008 banking crisis to police financial stability.
“The one thing that we are going to need to test is what would happen if we had a very large climate event in the UK, or possibly another major financial jurisdiction,” he told the Observer in an exclusive interview. Woods was speaking before the prime minister rolled back a string of net zero commitments, including delaying a ban on the sale of new petrol and diesel cars to 2035.
“Imagine Westminster under water – a really extreme thing that made policy shift in a very dramatic way,” said Woods. “I know thereare terrible climate events happening around the world all the time, but I’m talking about one that will lead to a dramatic change in policy from government, and governments … [and have a] very sudden effect in financial markets.
“We haven’t tested that – we’ve tested the slow burn thing of your risk building through time.”
The PRA has yet to confirm plans to repeat its inaugural climate stress tests, which last year showed that the UK’s 19 largest banks and insurers would collectively have to shoulder up to £334bn of losses through defaults, lawsuits and stranded assets by 2050 unless action was taken to curb rising temperatures and sea levels.
However, it is unclear whether fresh – or ramped-up – tests would lead to the kind of substantial changes in climate finance rules that campaigners have been calling for.
The Bank of England has been criticised for refusing to reveal the test results of individual lenders – including HSBC, Lloyds, NatWest and Barclays – in a move that has limited investors’ and campaigners’ ability to scrutinise their climate preparedness.
It has also been under fire for failing to introduce climate capital requirements that would force lenders to put aside funds to counterbalance climate-exposed assets including some mortgages and loans to heavy polluters.
Introducing those rules would make it more expensive for banks to offer loans and services to fossil fuel companies and carbon-intensive projects. Woods said current capital requirements already reflected the climate-related risks on banks’ balance sheets. However, he admitted that those calculations would “need to evolve through time”.
For example, the chances of borrowers defaulting on their mortgages would increase as the climate crisis put their home at a higher risk of floods or wildfires. “If the house that the mortgage is on is on a floodplain, and climate change is making floods more likely, then that probability of default is going up.”
He said banks were already expected to account for those slow-shift changes, but that more rigorous regulatory drills would confirm where they were ready for a sudden shift in climate-related risks. “When resources allow, I would like to do a test of that kind.”
