On 30th April this year the Prudential Regulation Authority (PRA) launched its consultation on “Enhancing banks’ and insurers’ approaches to managing climate-related risks – Update to SS3/19”.
The consultation may be found here: https://www.bankofengland.co.uk/prudential-regulation/publication/2025/april/enhancing-banks-and-insurers-approaches-to-managing-climate-related-risks-consultation-paper
The PRA, part of the Bank of England, supervises around 1,500 financial institutions, including banks and insurance companies. The aim of the PRA is to ensure that the financial services and products are provided in a way that does not put customers, their money or the economy at risk.
The PRA’s new proposals for updating the supervisory statement (SS) indicate that it is serious about getting banks and insurance companies to address both the transitional and the physical risks from a changing climate. The consultation covers both transition and physical risks. This article focuses on aspects that are relevant to physical risks, although many of the points made relate to processes used by firms and are also relevant to transition risks.
Understanding physical climate risks for banks and insurers
Physical risks arise from specific weather events, such as heat waves, floods, wildfires and storms. Risks also arise from longer-term shifts in climate, such as changes in precipitation, extreme weather variability, sea level rise and rising mean temperatures.
How physical climate risks impact financial institutions
Physical risks affect banks through their lending and investment portfolios, via both credit and market risk. For example, on the lending side, rectifying flood damage to a farm might affect the borrower’s ability to repay mortgage payments (credit risk) or reduce associated farm values. Physical risk is particularly relevant for classes of business for general insurers (GIs), including agricultural insurance, potentially reducing asset values (market risk) or increasing claims (underwriting risk).
PRA concerns: shortcomings in climate risk assessments
The PRA has found that many firms do not currently consider climate-related risk to be a material risk, yet firms’ conclusions are not based on an adequate assessment of climate-related risk exposures. Most banks have not established climate-related risk metrics or defined a climate-specific risk appetite. Current metrics used by insurers often do not directly quantify climate-related financial risks and, therefore, do not allow them to measure and monitor their climate exposures against risk appetite. In general, firms lack an in-depth understanding of climate-related risk transmission channels and often rely on judgement-based overlays. This highlights the need for more systematic climate risk assessment methodologies.
The PRA has observed that climate-related risk analysis provided to boards of banks and insurers is often unclear and is generally insufficiently specific or targeted. This potentially limits boards’ ability to assess the risks and provide effective challenge. As a result, climate-related risk may be inappropriately assessed and managed.
Regarding banks, the PRA is concerned about the high degree of variability in the quality of firms’ credit risk management capabilities for climate-related risks. Corporate client risk assessments are a key tool that many firms still do not employ appropriately for measuring and evaluating climate-related credit risks.
Regarding insurers, the PRA has noticed that insurers’ own risk and solvency assessments (ORSAs) do not always assess the potential impact of climate change with sufficient depth or granularity and that insurers’ solvency capital requirements (SCRs) do not consistently reflect the impact of climate-related risk in all relevant risk categories. Not all insurers are able to explain how the material climate-related risks are appropriately capitalised.
PRA’s two-step process for managing climate-related risks
In the new SS, the PRA proposes that all firms should adopt a two-step process:
- Step 1: Firms should carry out effective risk identification and assessment approaches to determine the material climate-related risks they are exposed to. They should understand how these risks will impact the resilience of their business model over relevant time horizons and under different climate scenarios, using scenario analysis.
- Step 2: Firms’ knowledge of their business, and resulting exposure to climate-related risks, will guide them towards a risk management response that is proportionate to their vulnerability to climate-related risk. Specifically, firms’ risk management response should be scaled to the materiality of the climate-related risks they face.
Firms should be able to evidence or explain how they have reached any judgements that underpin the outcomes from steps 1 and 2. The response should be proportionate: firms that are materially exposed to climate-related risk are expected to take greater action than those less exposed to climate-related risks.
The following revisions to the SS are also proposed:
- Management bodies should provide their board with the relevant information on climate-related risks. The board should ensure there is a periodic review of the firms’ risk appetite, climate-related risk management practices and strategy.
- All firms should develop quantitative risk appetite metrics and limits for each material climate-related risk that they face
- All firms should have sound practices and policies for assessing and measuring the impact of climate-related risk in their financial statements in accordance with accounting standards.
Requirements for banks: integrating climate-related risks into credit risk assessments
- Banks should have clear processes and policies to identify, measure, monitor and mitigate climate-related credit risks, including integrating climate considerations into credit risk assessments, evaluating climate-related risks across the credit life cycle and evaluating how these risks may impact their ability to recover loans.
Requirements for insurers: Incorporating climate scenarios into risk assessments
- Insurers should include climate scenarios in their ORSAs when climate-related risks are material and should capture the different time horizons of the risks in the risk management framework, ORSA and SCR.
- Insurers should detail the investment and underwriting changes they would make in response to climate-related risks and what metrics and indicators they would monitor to inform those decisions and their timing.
Conclusion & Recommendations
The PRA recognises that progress has been made by banks and insurers, but the consultation paper makes it very clear that they expect more. Assuming the consultation does not lead to a significant dilution of the proposals, the revised SS will ramp up the pressure on banks and insurers who are materially exposed to physical risks to get a better grip on the problem.
Resilience Constellation recommends that banks and insurers consider the potential for systemic risks emerging where key sectors, like agriculture, are deemed “risky”. If firms seek to limit their exposure to these sectors, the effect will serve only to weaken them further, compounding the climate challenges they already face. Assessing physical risk is a sensible step but does not solve the problem. Firms will need to go further, identifying and prioritising measures that help build resilience for key parts of the economy. Financial innovation will become increasingly important if physical risks are to be effectively managed.
Further information
The new draft of SS3/19 may be found here. https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/consultation-paper/2025/april/cp1025-appendix.pdf
The Bank of England is a member of the Network for Greening the Financial System (NGFS), a group of 144 central banks and supervisors committed to sharing best practices, contributing to the development of climate and environment-related risk management in the financial sector and mobilising mainstream finance to support the transition toward a sustainable economy. On 7th May, the network published the NGFS Short-Term Climate Scenarios, to help with the kind of scenario analysis that has been proposed by the PRA. More information can be found here: https://www.ngfs.net/en/publications-and-statistics/publications/ngfs-short-term-climate-scenarios-central-banks-and-supervisors
John Mayhew
COO Resilience Constellation