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BoE speech – It’s risk management, stupid!

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On 11 July 2022, the Bank of England (BoE) published a speech by Anil Kashyap (Member of the Financial Policy Committee). The speech is entitled “It’s risk management, stupid!”. In his speech Mr Kashyap describes some of the key findings from the climate change focused Exploratory Exercise, known as ‘CBES’ that the BoE recently completed with major UK banks and insurers.

Among other things Mr Kashyap highlights four areas from the CBES findings. In summary these are:

  • Modelling climate risk will require financial services firms to look at their customers differently than they do now. For many customers, business as usual will become impossible to sustain. This could occur for several reasons including that a product being sold becomes inconsistent with a world that features much higher carbon prices. Financial services firms will also need a lot of non-standard information and reporting requirements will need to change to make this information available. Every single respondent to the CBES had examples in their submissions for which they could not fully respond because they did not have the information that they needed available.
  • Firms differed greatly in the degree of granularity that they used in their modelling. As a high level, some firms think about top down approaches that suppose all firms in a sector are identical so that a single loss assumption for the sector is the essential driver of the results. Others use a very detailed bottom up approach that took borrower specific conditions into account.
  • Firms relied, to differing degrees, on third party consultants to assist in some aspects of modelling. It will take time for financial services firms to hire the staff that is needed and build up competence.
  • Many lenders plan to dial back business with so-called brown industries and are actively looking to establish ties to green industries. This will need to happen, but the overall health of the economy and financial system requires an orderly rotation.

In the final part of his speech Mr Kashyap sets out some questions that a management team of a financial services firm should be asking:

  • How much extrapolation are you having to do because of missing data? Perhaps more importantly, how are the gaps being filled in?
  • Do you know which third parties you are reliant on and what are their key assumptions/features of their models?
  • What is my firm best and worst at modelling and how will we level up our capability?
  • Going forward what are the key assumptions your institution is making about the trajectory of climate policy and physical risk and its impact?
  • If other banks are expecting to carry out the same strategic changes to their businesses that you are, would your planned response to climate risk still ne a workable/sensible one?

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