The Bank of England said on Tuesday that delaying climate change action could cost lenders and insurers as much as £350bn ($437bn) by 2050 if no further action is taken to cut carbon emissions.
It came as Threadneedle Street published the results of its climate “stress tests” which assess how banks and insurers are able to cope with severe economic scenarios.
The Climate Biennial Exploratory Scenario (CBES) explored the resilience of the UK financial system to the physical and transition risks associated with different climate pathways.
The Bank projected that total losses for the financial sector could reach as high as £350bn in a severe physical risk scenario, where no additional action is taken.
It said banks and insurers which do not properly manage risks could face a 10% to 15% hit to annual profits and higher capital requirements.
The report was the first comprehensive stress test on climate change, and tested the ability of 19 banks and insurers in total.
Lenders are currently facing pressure from climate activists to cut financing to fossil fuel projects.
It added that while the banks and insurers will likely be able to absorb the costs of the climate transition over 30 years, some of this might be passed on to customers.
Around 2 million — equivalent to 7% — British households that have insurance might be forced to go without cover because their properties would either be uninsurable or premiums would be too expensive.
“Projections of climate losses are uncertain. Scenario analysis in this area is still in its infancy and there are several notable data gaps. UK banks and insurers have made progress but still need to do much more to understand and manage their exposure to climate risks,” the Bank said.
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In October, the BoE’s Prudential Regulation Authority (PRA), which is responsible for regulating and supervising around 1,500 financial institutions, hinted that it was prepared to adjust the amount of capital banks hold to reflect climate risk to address the “financial consequences” of climate change.
The PRA also stated last month that from 2022, it will switch from "assessing" climate-related risks to "actively supervising" against them.
Sam Woods, the Bank of England’s deputy governor for prudential regulation, said: “Recent events such as the war in Ukraine and rises in energy prices illustrate the challenges banks and insurers can face from changes in their operating environment.
“Today’s exercise explores how well they are equipped to manage the longer-term challenges from climate change, in the context of our financial stability objective.
“We find that they are likely to be able to absorb the climate costs which fall on them without material risks to solvency, but will face significant headwinds and therefore need to continue to invest in their ability to support the economy’s transition to net zero.”
David Barmes, senior economist at Positive Money, said: “Today’s stress test results confirm what we already knew, that delay to climate action poses severe costs to the economy.”
“Estimates suggest that financial markets are aligned with 3°C of warming, so the Bank of England’s prediction that banks should be able to survive temperatures peaking at 1.8°C offers little comfort.”
He added: “With dire warnings from the International Energy Agency and IPCC against all new fossil fuel expansion, British banks are clearly out of step with any credible pathway to net zero, pouring £275bn into fossil fuels since 2016.
“The government and Bank of England must act fast to align the financial system with net zero. Outright restrictions on lending to new fossil fuel projects must now be on the table. At the very least, higher capital charges for unsustainable investments would force banks to cover their own losses when loans go bad, instead of falling back on the public purse.”