Bank Of England Plans Stronger Climate Risk Rules

The Bank of England (BoE), via its Prudential Regulation Authority (PRA), published a Consultation Paper with new proposals to enhance the oversight of climate-linked financial risks by insurers and banks. The step is a major move in the direction of integrating climate risk into the fundamental frameworks of the UK's financial system, as concerns about the effect of environmental change on the stability of markets increase. The consultation is available until 30 July 2025 and is to update the current Supervisory Statement 3/19, originally released in 2019.

The revised proposals seek to fix the sluggish rate of change by financial institutions following the BoE's first climate guidance. Per the PRA, although some institutions have started incorporating climate thinking, capabilities overall in both the banking and insurance industries are in their infancy. The regulator has discovered that most companies still do not have robust climate risk frameworks, do not consider climate change a material risk, and have not yet established concrete metrics or risk appetite statements related to environmental risks.

David Bailey, BoE's Executive Director for Prudential Policy, underlined the general systemic value of upgrading climate risk management. "Strong risk management in firms will assist in developing a more resilient financial system to cope with the rise in frequency and severity of climate events we are seeing and any shifts in the transition pathway," he explained.

The PRA review points out that the majority of banks have not yet articulated climate-specific risk appetites and frequently do not incorporate climate-related issues into their strategic and operational choices. Remarkably, numerous institutions do not consider climate change a material risk, but that judgment is often made on the basis of inadequate or faulty risk assessments. "Numerous firms do not presently regard climate-related risk as a material risk, but this is not a judgment that is based on a proper evaluation of climate-related risk exposures," the PRA said.

The insurance industry, although slightly ahead in terms of integrating climate risk into risk appetite frameworks, is also challenged. The PRA discovered that most insurers utilize broad or generic climate metrics that are not closely linked to financial outcomes. This gap impedes their capacity for measuring and tracking true exposures and restricts the effectiveness of their risk management. "Current metrics do not always directly measure climate-related financial risks and, as such, do not enable insurers to measure and track their climate exposures against risk appetite," the regulator added.

In response, the BoE's suggested refinements focus on three key areas: scenario analysis, climate risk appetite, and data governance. The PRA is requesting that firms improve their application of scenario analysis by not only comprehending scenario outcomes but also using insights to inform actual-world decisions. This involves illustrating how conclusions affect business strategy and risk-taking.

Moreover, the PRA also requires firms to create concise and quantifiable climate risk appetite statements that are reviewed periodically by their boards. These statements must capture the firms' true climate risk exposures and be incorporated into strategic planning processes. Data governance is also an important area of focus, with firms being asked to identify data gaps, put remediation plans in place, and have strong controls over the utilization of external data sources to maintain accuracy and consistency.

Notably, the PRA made it clear that these proposals are supervisory expectations and not binding requirements. Requirements will be proportionally applied depending on the materiality of a firm's exposure to climate risks. Smaller firms or firms with less exposure can scale their approach accordingly but are still required to exercise sound judgment and exercise prudence in their assumptions.

The suggested framework is in line with international best practices, and it draws from the world's leading institutions like the Basel Committee on Banking Supervision and the Network for Greening the Financial System. It also complements the work of the International Sustainability Standards Board (ISSB), which seeks to standardize and enhance the quality of sustainability disclosures across the world.

The BoE's conclusion is that more effective integration of climate risk into governance, strategy, and risk controls is critical to ensuring a resilient financial system able to withstand long-term environmental and transition-related change. The message to the regulator is unequivocal: climate risk is a material financial risk, and companies need to move quickly to integrate it into their risk management systems.