Why macroprudential policy needs to tackle financial stability risks from climate change − speech by Elisabeth Stheeman

Given at Queen’s University Belfast
Published on 03 May 2022

Elisabeth Stheeman notes that climate change and the transition to net zero have big consequences for the economy and the financial system.

She explains that central banks and supervisors have an important role to play, and need to act fast to make the UK’s financial system more resilient to any climate risks it faces. She then sets out what the Bank of England’s Financial Policy Committee is doing to help.


Thank you to Climate Northern Ireland and Queen’s University for having me here to speak to you today.

Let me start on a personal note. The environment and climate change have been an important issue for me for some decades. My upbringing in Northern Germany during the energy crisis of the 1970s made me acutely aware of the impact of our dependency on fossil fuels and their wider consequences for our natural environment. Because of the oil crisis, car-free Sundays were introduced, our old farmhouse was always cold, and we used bicycles to get everywhere. I remember how we recycled everything from newspapers to glass bottles. When I moved to the UK in the late 1980s I continued recycling everything, but had to search hard to find a bottle bank. Thankfully, now we can recycle most things locally.

But changes in our environment increasingly influence our everyday lives, and the need to manage the risks arising from this has been an important consideration in both my personal and professional life.

Climate change brings far-reaching economic, financial and social consequences. The associated risks are fast-approaching and action to mitigate them needs to be taken without further delay. I am an external member of the Bank of England’s Financial Policy Committee, or FPC, which looks at risks to the stability of the UK financial system. The FPC was created after the 2008 financial crisis because of the realisation that there needed to be a single body that could identify, monitor and work to reduce systemic risks to the financial system. Climate change is one of the sources of risk the FPC thinks about. As I will outline later, it has been on the FPC’s agenda for several years, initially from the perspective of assessing risks to insurers in the event of catastrophic climate events, and now from the perspective of system-wide impacts of climate-related risks.

I also sit on the boards of companies both in the UK and Germany, and am a fellow of Chapter Zero—the UK Chapter of the Climate Governance Initiative—which provides a knowledge base for non-executive directors on climate issues. In addition, I am an External Member of the Audit and Risk Committee of the Asian Infrastructure Investment Bank (AIIB) which gives me another lens of the challenges of climate change in Asia. Through these roles I have seen first-hand how climate-related financial risks and opportunities from the transition to a net zero economy have increasingly become a strategic focus for all businesses, both as a challenge and as an opportunity.

A systemic risk to the financial system

The financial risks from climate change can be seen through two main channels - physical risks and transition risks. I’ll briefly describe how these can play out:footnote [1]

  • Physical risks can arise from damage to property, land and other infrastructure as well as disruption to business supply chains and food systems. This could affect the safety and soundness of financial institutions that the Bank of England supervises, for example by reducing asset values or resulting in lower profitability for companies, and through insurance losses, or losses on mortgages. Inflation-adjusted insurance losses from climate-related damage have increased fivefold since the 1980s, to around US$50 billion per year. And uninsured losses can be multiples more.footnote [2] Smaller lenders with geographic concentrations could be more at risk of losses.
  • Meanwhile, transition risks stem from the move towards a net zero economy, arising from changes in climate policy, technology and shifting consumer preferences. This could prompt a reassessment of the value of a large range of carbon-intensive assets and lead to higher costs of doing business as a result. This impacts energy companies but also transportation, infrastructure, agriculture, and real estate to name just a few. The implied change in energy costs has already been having a significant effect on many businesses, even before the recent sharp rise in global energy prices following Russia’s invasion of Ukraine. In turn, this could give rise to credit risk for lenders and market risk for insurers and investors.

Climate-related risks could destabilise capital markets, and have the potential to cause disruption across the broader economy. Many of you run businesses, work closely with the business community, or are involved in climate research, and so will know this first-hand. The typical market response to escalating risk, of reducing exposure or hedging at an individual firm-level, does not necessarily work in aggregate for climate change. Put simply, firms cannot diversify away from their exposure to the planet. And in that sense, climate change could be described as the ultimate systemic risk.

A number of factors—such as a lack of climate risk disclosure by firms, an absence of clear sector-level climate policies, firms not internalising the cost of emissions, and the short time horizon of some investors—have contributed to what was described in the Stern Review in 2006 as the “greatest market failure the world has ever seen”.footnote [3] A failure to price climate risks sufficiently could lead to significant financial losses.

There is now widespread agreement amongst global policymakers and industry that climate change poses increasing and material financial risks. These risks cannot be addressed or mitigated by individual institutions alone, and that includes central banks. Ultimately, these risks are mitigated by reducing greenhouse gas emissions across the economy. The main responsibility for driving that outcome lies with governments, rather than central banks, through setting climate policy. The UK Government has legislated for net zero by 2050. It has published a strategy to achieve that, but as with many governments around the world the full set of detailed policies still need to be worked out.footnote [4]

Responsibility for achieving net zero also lies with industry through innovation and climate action, with private finance through facilitating investment to support those changes, and with consumers through the spending and personal investment choices they make. But this is hard, as actions need to be taken against a background of emerging policies, and an ever-changing external environment. For example, the impact on the transition to net zero of the increase in energy prices, as a result of Russia’s unjustified and illegal invasion of Ukraine, is yet to be determined. The increased demand for coal which we have seen is not consistent with a steady path to net zero. However, I take some comfort that the incentives to invest in renewable sources of energy have now been bolstered. Recent events have highlighted the transition risks that businesses face. In light of this situation, the role for central banks and supervisors is to continue to help build resilience to climate-related financial risks, and in doing so they can also help support the transition.

The good news is there has already been some progress in the regulatory space, with central banks and supervisors having established the Network for Greening the Financial System, or NGFS. The NGFS–now over 100 members strong–has had a central role in establishing that climate change is a financial stability risk, and has embarked on the task of integrating climate-related risks into supervision and financial stability monitoring.footnote [5] The Financial Stability Board has also played an important role in assessing the channels through which these risks could impact financial stability, and is studying the data needs to monitor and assess these appropriately.footnote [6] footnote [7]

In November 2021, the UK hosted the UN climate conference, or ‘COP26’, which brought together almost 200 countries to discuss climate action. What needs to be done in the financial system was a major part of this, with finance ministers and central banks jointly committing to work on policies that support and enable an orderly transition, and on ensuring the readiness and resilience of the financial sector.

At COP26, the International Financial Reporting Standards Foundation (IFRS) announced the creation of an International Sustainability Standards Board (ISSB) to deliver a global baseline of disclosure standards, which the ISSB is now consulting on. This should provide the financial sector with information on firms’ sustainability-related risks.footnote [8] Greater transparency on firms’ approaches to climate change is key to enabling the right action by governments.footnote [9]

Responsibility of the FPC

It is clear therefore, that the financial system also has an important role to play in supporting an economy-wide and orderly transition to net zero. As some of these financial risks could pose a systemic risk, they are in the domain of the FPC.

The FPC is particularly well-placed to help deal with risks to the financial system arising from climate change and the net zero transition. Climate-related financial risks have similar features to other financial stability risks, which reflect the distinct challenges associated with financial stability policymaking, and in which the FPC has a comparative advantage. As I have mentioned, climate-related financial risks are systemic, with their impact likely to be correlated and therefore felt widely. They are also non-linear, meaning that they don’t unfold in a smooth or straightforward manner. Another feature is that climate-related risks are foreseeable, and they are also uncertain, in that we don’t know when they will emerge. Finally, when and how they unfold in the future is dependent on actions taken in the short-term.footnote [10]

The Bank of England first approached climate change in 2015–before the Paris Agreement–through assessing risks in the insurance sector, then publishing supervisory expectations in 2019, and more recently by exploring the system-wide impacts through scenario analysis. Importantly, the Bank’s actions are grounded in its mission to promote the good of the people of the United Kingdom through maintaining monetary and financial stability. Climate change and the transition to net zero can affect the safety and soundness of the firms the Bank regulates, the stability of the wider financial system, and the economic outlook. It is therefore clear that climate change and the transition to net zero have economic and financial consequences that are relevant to the FPC’s responsibility to monitor systemic risks. As the challenge has become clearer, so has the Bank’s particular role in responding to it. Furthermore, other central banks have also committed to further incorporating climate change considerations into their policy frameworks.footnote [11]

In addition, the FPC has a secondary objective to support the UK Government’s economic policy. This means it also has a role to play in supporting the Government’s ambition of a greener industry, using innovation and finance to protect our environment and tackle climate change.footnote [12] Moreover in April, the Government recommended that the FPC should have regard to the important role that the financial system will play in supporting the UK’s energy security—including through investment in transitional hydrocarbons like gas—as part of the UK’s pathway to net zero.footnote [13]

Work the FPC is doing

In order to better assess climate risks and their implications for financial stability, the FPC—jointly with the Bank’s Prudential Regulation Committee, or PRC—has been undertaking a climate scenario exercise, or CBES, to assess the resiliency of major UK banks, insurers, and the wider financial system to different climate scenarios. Because of its ability to accommodate the distinct characteristics of climate-related risks that I described earlier, climate scenario analysis is a key tool in assessing and managing these risks.

The Bank’s climate scenario exercise builds on the scenarios developed by the macrofinancial workstream of the NGFS, to consider how financial sector risks evolve under a range of potential future scenarios.footnote [14] There are three different scenarios the exercise explores:footnote [15]

  1. The first where early policy action is taken for an orderly transition to net zero emissions;
  2. The second where policy action is delayed and introduced more severely to compensate for lost time, leading to a sharp and disorderly transition to net zero emissions;
  3. And finally a third where no additional policy action is put in place by governments leading to a growing concentration of emissions in the atmosphere and, as a result, a continued increase in global temperature levels that exceeds the goals set under the Paris Agreement.footnote [16]

This scenario exercise will help both policy Committees learn from major UK banks and insurers about the extent of the exposures in the financial system to climate-related risks. The exercise is not intended to inform the setting of capital requirements. The FPC will also use it to understand risk management capabilities in the financial sector, and how banks and insurers may adapt their business models in the face of different climate pathways.


To conclude, the FPC cannot solve climate change and drive the transition – government, industry and all of us as individuals too have the responsibility and the tools to do this, through climate policies and innovation and climate action respectively. Having said that, the FPC’s role is to ensure that the financial system is resilient to climate-related financial risks, and thereby it can support the transition to net zero. As part of the CBES exercise, the Bank is now focusing on further exploring major UK banks’ and insurers’ prospective responses to the crystallisation of climate risks, and expects to publish results this month. It is also important that the FPC understands the broader macroeconomic and macrofinancial impacts from climate change and the transition. In doing so, the FPC also helps to support the Government’s own climate policy actions.

The work the Bank of England and the FPC in particular are doing will contribute to progress towards assessing and mitigating the financial risks from climate change. In cooperation with other policymakers, we will continue to play our part in tackling climate-related financial risks. Climate change is an unprecedented challenge, which will demand an equally unprecedented degree of international cooperation today, tomorrow and in the future.

I am grateful to Andrew Bailey, Grainne McGread, Danielle Haralambous, Chris Faint, Maria Pardo, Thomas Viegas, Timothy Rawlings, Zane Jamal and Theresa Lober for their assistance in drafting these remarks.