The Bank of England will consider whether it should force banks to hold extra capital to cover risks from climate change, as central banks come under pressure to assess any shock to the financial system.
The central bank’s Prudential Regulation Authority said on Thursday that it would examine whether changes to bank capital buffers might be necessary to manage the impact of climate change, and it would publish its findings by the end of 2022.
But the authority distanced itself from the responsibility for directing money flows. It stressed that capital requirements should be used only to address the effects of climate change, and to absorb any losses.
Steering the move to a low-carbon economy was the responsibility of government, it noted.
The UK took steps to become the first country in the G20 to force certain companies to disclose their climate-related risks, as it introduced legislation on Thursday that would make it a requirement from next April.
Pressure has grown on global banking regulators to address the potential risks to the financial system from the estimated $750bn tied to fossil fuel assets in the major banks alone.
Among the actions the PRA could take is to require banks to set aside capital both on a system-wide basis and on an individual basis, requiring banks to cover their specific exposures.
Hedge fund manager Chris Hohn told the Financial Times this month that he believed central banks were “allowing systemic risk to build” by “not doing their job to regulate carbon”.
Hohn’s Children’s Investment Fund Foundation said in response to the latest PRA statement that capital buffers were critical. “Capital charges exist to ensure the financial system is safe from systemic risk including climate change — higher charges for dirty assets with higher transition risk is essential,” said Mike Hugman, CIFF director of climate finance.
Al Gore, former US vice-president, also said in an interview with the FT that banks’ capital requirements should be changed to incorporate climate, in order to dissuade financiers from investing in “destructive practices”.
The PRA maintains that it is for policymakers to dissuade investors from ploughing money into carbon-intensive investments. Direct policy interventions, such as putting a price on carbon emissions, “would offer better incentives for action across the wider economy”, it said.
The Brussels-based non-profit group Finance Watch said the PRA was taking “the right approach”. Current capital requirements underestimated the risks associated with carbon-intensive investments, and changing the rules would “effectively orient capital towards sustainable activities”.
The PRA was not dictating banks’ investment decisions, said Thierry Philipponnat, Finance Watch head of research and advocacy, but it could change capital requirements to ensure that any lender taking on risk did not trigger a systemic problem.
In justifying its position, the PRA said capital requirements “seem unlikely to be the most effective tool in reducing carbon-intensive activities unless calibrated at more extreme levels”.
This could lead to “unintended consequences”, it said, such as investments classified as “green” being treated as less risky than they may turn out to be.
That could have “financial stability implications”, and also deprive key sectors of the financing they needed to transition to greener business models, the PRA said.
The European Commission has asked the European Banking Authority to assess whether capital requirements could be altered to take into account climate risk. The commission said this week that the introduction of new rules on bank capital would be delayed until 2025.
Also on Thursday, the UK’s Financial Conduct Authority said that most asset managers and listed companies had not yet set net zero emissions targets, despite many having committed to doing so and signing up to industry-led initiatives.
The FCA said some institutions were concerned that setting climate goals would force them to reduce their exposure to certain clients or asset classes, which could “conflict with their business relationships”, such as their client’s instructions to invest in those assets.
