UK Finance, which represents over 300 financial institutions, has said that its members ‘strongly support’ the Bank of England’s decision to conduct a climate change stress test.

On Tuesday the bank announced it would run an extensive stress test to explore the financial risks posed by climate change for the largest UK banks and insurers.

The bank runs regular exploratory scenarios to help assess the resilience of the UK financial system and individual institutions.

The trade association said that the banking and finance industry has a “key role” to play in supporting a sustainable future.

“Together with the government and Bank of England, lenders are supporting the transition to a low-carbon economy, putting climate responsibility and risk management at the core of their businesses,” said UK Finance in a statement.

It added that testing the resilience of the financial system to climate risk is an important step and that its members are supportive of the bank’s “pioneering role” in this area.

The Climate Biennial Exploratory Scenario (CBES) test explored the risks arising from the significant structural changes to the economy needed to achieve net zero emissions, which the bank describes as ‘transitional risk.’

The 2021 exercise also addressed the risks associated with higher global temperatures, or the ‘physical risks.’

The CBES used three scenarios of early, late, and no additional action to explore the two key risks. These scenarios are built on a subset of the Network for Greening the Financial System scenarios, which are applied over a span of 30 years, which the bank said reflects the longer-term nature of climate-related risks.

Other features of the stress test include sizing the risks banks and insurance face based on their current (fixed) balance sheets. For banks, the exercise focused on their credit books, whilst for insurers, the exercise assessed risks to both their assets and liabilities.

The stress test also included a qualitative questionnaire to capture bank and insurer views on their risks, their approach to climate risk management, and their potential management actions.

Firms were obliged to conduct a detailed, bottom-up ‘counterparty-level analysis’ on their largest counterparties, involving using novel modelling approaches.

For the remainder counterparties, financial institutions were expected to differentiate exposures by geography and sector.

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