BoE sets out its thinking on regulatory capital and climate risks

The Bank of England (BoE) published a working paper that aims to understand the climate-related disclosures of UK financial institutions. In another report, the central bank sets out its latest thinking on climate-related risks and regulatory capital frameworks; the report includes updates on capability and regime gaps and areas for future research and analysis.

In the report on climate risks and capital frameworks, BoE identified a number of next steps and will:

• Maintain its focus on ensuring that firms make progress to address capability gaps to improve the identification, measurement, and management of climate risks. 
• Further develop its capabilities to test the resilience of the financial system to climate risks. This includes how scenario exercises and stress tests can help BoE and firms to understand the exposure of the financial system to risks not captured by the Climate Biennial Exploratory Scenario (CBES). BoE will work domestically and internationally to develop the toolkit required to facilitate this analysis.
• Progress work to understand material regime gaps in the capital frameworks and explore whether a broader range of prudential tools might be appropriate, including those that may be more robust to uncertainty than micro-prudential tools. This also includes concentration limit approaches and broader macro-prudential policies.
• Support ongoing international and domestic initiatives to enhance climate disclosures by the wider economy needed by banks and insurers to manage and measure risk, including adoption of the International Sustainability Standards Board (ISSB) standards.
• Play an active role in promoting high-quality and consistent accounting of climate risks, given accounting is a foundational building block of the capital framework for banks.
• Continue business-as-usual supervision against firms’ progress at embedding supervisory expectations in these areas as set out in SS3/19 (titled "Enhancing banks’ and insurers’ approaches to managing the financial risks from climate change"). This will also involve work to build an understanding of banks’ evolving approaches to Pillar 2A capital add-ons through ongoing supervisory review and evaluation process. It will also consider whether further guidance or updates to the expectations set out in SS3/19 are warranted over time.
• Continue to engage in relevant discussions at international fora on how regulatory frameworks and supervisory practices need to be adjusted to account for climate risks.

The paper on climate-related disclosures examines the degree to which climate-related regulatory publications by the Prudential Regulation Authority affect disclosure decisions of firms. The study first uses natural language processing techniques and machine learning classifiers to retrieve, from firms’ public reports, climate-related information disclosed in line with different TCFD recommendations. It then examines which characteristics of firms are related to their disclosure decisions. The data show that climate-related policy communications in the form of regulatory guidance on future mandatory disclosures is associated with a catch-up by firms previously disclosing less. The study found evidence of a significant effect of regulatory announcements on the decisions of firms to disclose climate-related information. However, a significant number of firms still do not disclose any information. The findings provide some interesting insights for policy makers when considering mandating climate-related disclosures. Before regulatory interventions, only a fraction of firms disclosed climate-related information in line with TCFD and these were on average larger firms. This gap in voluntary disclosures creates a case for regulatory interventions encouraging smaller firms to disclose too. Indeed, the results suggest that regulators setting clear timelines for mandatory disclosures can help accelerate the trend in disclosures, which leads to convergence across firms.

Related links:

• Report on climate risk and capital framework
• Working paper on climate disclosures