Measure, Model, Tackle, Tailor: The Bank of England’s approach to assessing and managing climate impacts across its core objectives - speech by James Talbot

Speech

Introduction

It is a great pleasure to be here this evening at this LSE event Chaired by Lord Stern. It is nearly twenty years since the Stern review, which showed that climate change could, among other things, have a serious impact on GDP in the long run.

Indeed, we are well used to thinking about climate change as something that happens in the long run.

Scientists have been thinking about this issue for around forty years, economists for thirty years and governments have been taking policy action for more than twenty-five years.

While economists may debate what horizon the long run refers to, those time periods would surely qualify…

Central banks are still a relative newcomer to thinking about these issues. At the Bank of England, our work on climate began around twelve years ago with an initial focus on the insurance sector. For the economists in the audience, that might qualify as at least approaching the long run…

Nine years ago, we were one of eight founding members of the Network for Greening the Financial System (NGFS), which was set up as a voluntary forum to enhance the role of the financial system in responding to climate change.

Today, we are responding to the implications of climate change right across the Bank’s policy objectives. In addition, the NGFS counts around 150 member institutions worldwide.^{footnote [1]} Considering the impact of climate as a central banker is now the norm, not the exception.

That is because the impacts from climate change are intensifying, and the effects are felt increasingly today. Global temperatures are estimated to have averaged more than 1.5 degrees higher than pre-industrial levels over the past three calendar years.^{footnote [2]} The rise in temperatures has already increased the frequency and intensity of extreme weather events, with heavy precipitation becoming more frequent and more intense globally.^{footnote [3]} Unsurprisingly therefore, the economic impact of climate change is rising.

At the same time, central banks have assessed the implications for the financial system and worked with firms to assess the impacts of climate-related risks under different scenarios.^{footnote [4]}

Action to respond to a changing climate and to drive the transition can have an impact on both the economy and financial system. While the policies needed to mitigate climate change are for governments, not central banks, to decide, if they have an impact on the economy and financial sector, central banks will need to understand them, just like any other shock.

The Bank of England’s mission is to promote the good of the people of the United Kingdom by maintaining monetary and financial stability. Our objectives are set by parliament and are defined through remits set by the government for our policy committees. To summarise:

• For the Monetary Policy Committee (MPC), the primary objective is price stability. When climate-related shocks move inflation and activity over the policy horizon – for example, through their effects on energy, food or supply chain disruption – the MPC will need to understand those impacts.^{footnote [5]}
• For the Prudential Regulation Committee, the primary objective is the safety and soundness of the firms we supervise and, for insurers, policyholder protection. Because climate change and the transition create operational and financial risks for firms, supervisors of banks and insurers will expect firms to understand and manage these risks appropriately and to take a strategic view of how to tackle them moving forwards.
• And for the Financial Policy Committee, the primary objective is to protect and enhance the stability of the UK financial system. In order to do that, we need to monitor and assess how the impacts of climate change build and transmit across the system as a whole.

Different central banks have different mandates. For the Bank of England, the impact of climate change matters for our primary objectives, given to us by Parliament. In addition, each of these committees is asked to have regard to the government’s economic policy objectives, which include the transition to a net zero economy. Climate also matters to the PRA’s secondary competitiveness and growth objective because failing to address climate risks effectively could, in time, hinder firms’ ability to support their customers and ultimately wider economic growth.

But considering climate change does not rest on a specific mandate. My point is simple: if climate change and the transition are impacting the macroeconomy and financial system, then this matters for our primary goal of maintaining monetary and financial stability. That is why so many central banks are now focused on these issues.

You’ll be pleased to hear that I am not going to try to summarise everything we have done on climate over the past decade and more this evening. Many of my colleagues – past and present – have done that very eloquently. Instead, I will highlight what’s new in our work in the last few years and where we are headed next. 

What have we been up to?

Broadly speaking, there have been three phases:

1. Establish whether climate change is relevant to our objectives;
2. Size the impacts where it is; and
3. Work out how to address these impacts so that we can deliver on our objectives.

Our work is at different stages across our different responsibilities. We started with the risks to the firms we supervise, first insurers and then banks. We then moved onto scenario analysis and the impact on the financial system as a whole. And finally, as the economic impacts of climate begin to manifest themselves over the shorter-run horizon relevant for monetary policy, we have increased our focus there too.

This has not been a straight line. There is a feedback loop. We have reassessed and refined our approach to support better decision making. Our recently updated supervisory expectations for banks and insurers are a practical example of how we have improved our understanding over the past six years from talking to firms. We have also learned from international best practice too. When we began this work, the rooms where we met were small, and the ideas were novel, but with more central banks and supervisors now working on this agenda, we are able to draw on the thinking and analysis of many others to improve our own understanding.

This is the strength of international fora like the NGFS and industry networks such as the Climate Financial Risk Forum (CFRF). That also means we do not need to lead on everything, which is especially important in a world where central banks need to understand an increasingly broad set of risks.^{footnote [6]}

Where we have established that climate matters for our objectives, we are increasingly focused on factoring that into our core policy-making responsibilities. As our work has moved from the conceptual to the applied, we’ve spent more time building the tools, data and approaches to take necessary action. Today, I want to share some of that progress – setting out the current state of play, the lessons so far and the priorities we will pursue next.

Monetary policy – how climate links to our objectives

The monetary policy horizon is typically short – usually around two to three years. While that is not the long run under anyone’s definition, as we begin to see climate change affect the economy, those impacts become a relevant consideration for monetary policy.

While monetary policy is the most nascent part of our climate work, our focus is beginning to intensify. Over the past four years, my work as chair of the NGFS Workstream on Monetary Policy, has brought together more than sixty central banks to set out a framework and analytical foundation to assess the impact of climate change on the economy. These central banks bring different skills and experiences – they include oil exporters and importers; low income, emerging market and advanced economies; and countries where the physical effects of climate have already become much more prominent.

In doing this work, we take both the scientific evidence and government climate policies as given. What we want to understand is how climate change affects the economy. There are two main channels. First, physical hazards like rising temperatures, floods and storms that hit supply, demand, trade and productivity. Second, transition policies can drive large and sometimes persistent relative price movements, shifts in investment and reallocation of production across sectors of the economy.

We began by building a conceptual framework to understand how acute physical impacts from climate change and the transition policies implemented by governments can affect the macroeconomy over horizons relevant for policymakers. We are now moving from that framework to modelling – exploring how to incorporate those channels into central bank toolkits so the analysis is usable in practice. In a forthcoming NGFS publication, we will also publish an assessment of how climate change affects monetary policy strategy.

Let me briefly summarise the conclusions of the work that we have done so far at the Bank of England and the NGFS.

Central banks have long noted weather as a key driver of prices and activity, responding accordingly. Back in 1805, the Bank installed a wind dial in its boardroom, connected to a weathervane on the roof. An easterly wind signalled an increase in trade, as it allowed merchant ships to sail up the Thames to the Port of London – and a need to increase the supply of banknotes in circulation.

Over two hundred years later, the impact of weather on the economy is somewhat different, but arguably just as important.

Sizing these effects is difficult. Much of the analysis is based on periods when shocks were smaller. An increase in the frequency, scale and persistence of climate-related events means that historical relationships may under-estimate the impacts. If climate dynamics are non-linear, we may also understate tomorrow’s risks.

For example, there is growing evidence that climate change is affecting food and energy prices.^{footnote [7]}

Research by the European Central Bank found that the summer 2022 extreme heat caused a cumulative impact of 0.7 percentage points on annual food price inflation and an increase of 0.3pp on annual headline inflation in Europe.^{footnote [8]} But projections under plausible but severe warming scenarios signal much larger and more persistent effects within the next ten years.^{footnote [9]}

More frequent heatwaves, droughts, floods and severe storms can interrupt production and raise transportation costs.^{footnote [10]} For example, De Winne and Peersman (2021) have shown that a 10% increase in global agricultural commodity prices stemming from weather-related shocks lowers GDP by 0.5% after six quarters across a panel of 75 countries.^{footnote [11]}

Climate transition policies can also have an impact. Let me pick out three examples, based on analysis at the Bank of England:

• The size and composition of business investment will change. The UK’s Climate Change Committee (CCC) estimates that a net zero-consistent pathway for the UK requires average financing of around £37 billion per year between 2025 to 2050.^{footnote [12]} Evidence from the Bank of England’s 2023 Decision Maker Panel survey of UK firms^{footnote [13]} suggested that climate-related investments were set to rise from 2.5% of capital expenditures 2020-2023 to 5.5% over 2023-2026.
• Our models suggest that an increase in carbon prices in the Emissions Trading Scheme operate much like other supply-side shocks: increasing inflation, and decreasing output, within the monetary policy horizon.^{footnote [14]} For the UK, we estimate that a 7% rise in the carbon price leads to an increase in energy CPI inflation of 1pp after a year, followed by a smaller, but more persistent, rise in non-energy CPI inflation of just over 0.1pp four months later, and a 0.05% temporary fall in GDP around two years after the initial shock.
• The composition of the UK energy market is also changing. As more renewable electricity is generated under fixed-price contracts for difference (CfDs), household bills should become less exposed to gas price spikes, with the CfD share of electricity supply rising to around 25% by 2027/28.

In my speech last year, I discussed work at the Bank using a DSGE model adapted to incorporate climate-related policies. A forthcoming NGFS report uses the IMF’s GMMET model to show the impact of an orderly phase-in of policies aligned with countries’ nationally determined contributions. It shows that while carbon taxes can be very effective in reducing emissions, they can push up headline inflation and reduce output in the near term, creating a trade-off for policymakers. Our modelling suggests that these trade-offs can be reduced when carbon tax revenues are spent on subsidies to green sectors. It also shows that if the transition is more abrupt, or agents doubt the credibility of announced policies, the inflationary effects are likely to be higher in the short-term.

This analysis shows that climate change can have important macroeconomic effects. In light of that, it becomes one of the factors we consider when setting monetary policy. My colleagues Sarah Breeden and Catherine Mann have spoken about some of these effects in recent speeches.

Physical climate shocks often look like supply shocks, pushing inflation up and output down, creating a trade-off for policymakers to manage.

If shocks are temporary, for example isolated weather events, then it makes sense for policymakers to “look through” the first-round effects. But if climate shocks become larger and more frequent, monetary policy may need to lean further against second round effects. So our work to understand these shocks better will be increasingly valuable.

The Financial System – sizing the risk

Our financial stability work has followed the same arc as that of monetary policy - but is further along. In 2021, the Climate Biennial Exploratory Scenario (CBES), our learning-by-doing exercise, was a first step in quantifying the impact of climate-related risks on the UK financial system in the long-run. It also found that a timely, well-managed transition keeps system costs lower relative to late or no action pathways.

But what of the near term? In the November 2024 Financial Stability Report, we set out a framework to help identify and assess climate-related risks to UK financial stability (see Appendix). One of the things we flagged was that some financial markets could be under-pricing the risks to corporate borrowers’ resilience posed by climate change and the transition.

Figure 1: Framework from the November 2024 Financial Stability Report showing how climate-related risks could impact the financial system and the real economy

So what if markets did start to price in risks suddenly – referred to by some as a climate “Minsky moment”? In the December 2025 FSR, we showed that a sudden reassessment of the costs of transitioning to net zero or the increase in physical risks from persistently elevated emissions could lead to a material adjustment in asset prices.

If such a repricing happened quickly it could have implications for financial stability, including by exposing non-bank financial institutions to material losses. In that case, it could also be amplified by the responses of financial market participants, in line with the findings of the Bank’s 2024 system-wide exploratory scenario exercise.^{footnote [15]}

This accumulation of evidence points to climate risks to financial stability becoming more proximate, albeit with significant uncertainty about when and where they will crystalise. These risks have a lot in common with other financial vulnerabilities that we monitor. Accordingly, we are working to make climate risk assessment part our day-to-day financial stability analysis. In order to do that, we are investing in our own risk assessment capabilities, using scenario analysis, among other things, to understand how climate factors interact with traditional risk drivers and to assess the materiality and proximity of risks under different transition and physical pathways.^{footnote [16]}

We are also developing the tools to assess and monitor the build-up of risks to financial stability over longer-term time horizons, for example through increasing physical impacts of climate change. A key channel here are changes in insurance protection, where lower coverage could transfer risks to households, businesses, banks and governments. In the short-term, the impacts on households are likely to be cushioned by a combination of Flood Re - the joint Government‑industry reinsurance scheme that improves insurance affordability and availability for some UK households – and high insurance coverage.^{footnote [17]}

But as physical risks intensify, cover could become harder or costlier to obtain, and the protection gap could widen. Today 6.3 million properties in England are in flood‑risk areas, rising to about 8 million by mid‑century.^{footnote [18]} Flood Re also ends in 2039 and has a statutory objective to manage the transition of the market to risk reflective pricing. Longer-term, households could face materially higher insurance premia or repair bills, lower house prices and difficulty remortgaging. Corporates could face potential capital losses and banks higher credit losses.^{footnote [19]} For the Bank of England, understanding those interactions will be vital,^{footnote [20]} as will assessing how actions on physical adaptation and resilience (e.g., better defences or smarter land-use) can reduce risks to financial stability.

Supervision – from principles to day-to-day practice

The supervision of banks and insurers is where our climate work is most developed. Having focused on developing our understanding and supervisory capabilities in recent years, our priority going forward is on supporting firms to develop the tools and drive capabilities they need to manage these risks in a way that works for them.

We started a decade ago with insurance, showing how physical risks could feed through underwriting, claims and asset exposures.^{footnote [21]} We then broadened the focus to include banking, setting expectations on governance, risk management, scenario analysis and disclosure in supervisory statement 3/19 - the first of its kind by a prudential regulator.^{footnote [22]}

Our supervisory expectations mattered. Boards and senior management were expected to treat climate as a financial risk - with clear accountability, risk monitoring and regular oversight through existing governance and risk‑management structures. From 2022, we moved from setting expectations to integrating climate into normal supervisory engagement with firms.

Since the expectations were issued, banks and insurers have taken concrete and positive steps.^{footnote [23]} However, firms’ level of readiness to manage climate-related risk vary and our overall assessment was that all firms needed to make further progress.

By 2024, the feedback from both firms and supervisors was clear: the work we had done was helpful, but more clarity and practical detail was needed.^{footnote [24]} While our work was cutting‑edge in 2019, thinking had moved on – both internationally and domestically.

In April 2025 we consulted on enhancements to our expectations, and in December 2025 we published a policy statement with an updated supervisory statement (SS5/25). Our approach is proportionate, risk-based and pragmatic. It recognises that materiality depends not only on a firm’s size, but also on its business model and geography.^{footnote [25]} This allows firms to scale their response to reflect the risks they actually face.

We want banks and insurers to have the capabilities – and the senior level engagement – needed to treat climate-related risks like any other operational or financial risk and manage them through their existing governance and risk management arrangements. That means clear senior ownership, information flowing to the board, and evidence that climate considerations are shaping strategy and day‑to‑day decisions. That is why we have provided clear expectations on how firms should identify, assess, monitor and manage climate‑related risks in a decision-useful way.

The aim is a more consistent and credible standard of practice across the industry, while still allowing flexibility in how firms get there. At the core of our approach is a robust, credible assessment of risk. We’ve tried to strike a balance – with more detailed expectations, where needed, while allowing flexibility and innovation and avoiding a one‑size‑fits‑all burden for firms with limited exposures.

Climate scenario analysis is a good example of this. Our expectation is that firms begin with the question they are trying to answer, whether that is portfolio resilience or how risks evolve over different time horizons, and then pick and tailor the scenarios accordingly. Done well, scenarios help boards and risk committees spot vulnerabilities, set priorities and inform strategy, particularly where historical data or backward‑looking models fall short.

We also recognise that firms are building capability in an area where methods, data and best practice are still evolving. That is why, together with the FCA, we co‑convene the Climate Financial Risk Forum (CFRF), which works in partnership with industry to provide practical guidance, case studies and tools to help firms accelerate their capabilities and support better decision‑making.^{footnote [26]}

Risk management of the Bank of England balance sheet

We expect the firms we supervise to both manage and disclose their climate-related risks. So, we are holding ourselves to the same standards.

First of all, we need to manage the risk on our own balance sheet. In order to help protect against climate-related financial risks, we have increased the insurance – or so called “haircuts” – and tightened the criteria for, the mortgage-loan collateral we take in our lending operations.^{footnote [27]} This is designed to protect our balance sheet from any potential losses on these assets arising from energy price shocks and flood risks and to ensure that buy-to-let mortgage collateral meets the government’s energy efficiency standards.^{footnote [28]} Taken together these measures cover more than three quarters of the collateral underpinning lending in the Sterling Monetary Framework (SMF).^{footnote [29]}

We have also conducted extensive work to better understand – and where appropriate manage – climate risks to our financial counterparties as well as the assets we own outright as part of our circa £500bn sovereign bond holdings.^{footnote [30]}

Second, the Bank of England publishes an annual climate‑related financial disclosure, aligned with the TCFD framework, covering governance, strategy, risk management, metrics and targets. The 2025 disclosure covers each of these areas, including analysis of the climate-related risks to our financial operations, including sovereign holdings and collateralised lending. Publishing a stand-alone climate disclosure aligns the Bank with our own updated supervisory expectations.

Where next?

We’ve achieved a lot in the past decade or so, but climate change isn’t standing still, so neither are we.

Going forward, our aim is to mature and evolve our work through the cycle of repeated challenge, analysis and implementation. We’ve done the foundational work to assess how climate change impacts central bank objectives. A lot of what’s to come is about ensuring it’s embedded in the ‘business as usual’ of what we do.

We have further to travel on monetary policy. This work is important against the backdrop of the shocks we have experienced in the UK over the past few years. Repeated and persistent supply shocks have previously pushed up food and energy prices. These pressures were driven largely by geopolitical events, but they underline how future shocks - including those linked to climate change - could also influence the path of inflation.

While we expect inflation to return to target later this year, our challenge won’t necessarily get any easier as our climate changes. My colleague Megan Greene noted that “the supply side demands more attention” and the Governor has recently flagged four headwinds to growth. Climate shocks are squarely on both lists. As we move forward, like any other shock, the challenge is to judge persistence early, explain our reasoning clearly, and keep expectations anchored, particularly where temporary weather-related disturbances morph into longer-term structural trends.

The need to assess more frequent climate shocks also reinforces the value of scenario analysis. Physical hazards, transition policies, and policy uncertainty all shift the distribution of risks around the baseline. One of the recommendations of the recent Bernanke review of forecasting at the Bank of England is to make more systematic use of scenarios for monetary policy. We have begun to include such scenarios as part of the MPC’s regular communications. In the future, as our modelling of climate-related risks improves, these insights could increasingly feed into how we calibrate monetary policy in an uncertain world.

On the financial stability side, we will also continue to use scenarios and system wide analysis to run targeted deep dives, so we can improve our understanding of where risks might build or spill over. We also need more and better data on these risks. Last year we did a targeted data collection to improve our understanding of the materiality of banks’ exposures to physical and transition risks, and we are now considering how such risks should best be captured within our regular stress testing framework.

Following the publication of our recent supervisory statement at the end of last year, our focus is turning to implementation. A key next step – for firms and for us – is investment in climate scenario analysis capabilities, tools and best practice. The ask is not to run scenarios for their own sake, but to use them as a meaningful decision tool, supported by strong governance, clear objectives, and a proper understanding of their limitations. In doing so, firms should remain strategically ambitious as they continue to evolve their capabilities to address climate-related risks.

We know from experience that maintaining financial stability is much more than the sum of its parts. Ensuring individual firm resilience is important, but we want to make sure the financial system provides vital services – like payments, credit and insurance – to households and businesses reliably in all states of the world. That creates a genuine, and legitimate tension for insurers and regulators. Insurers must manage their own risk prudently, but if they decide to increase pricing or withdraw cover so that losses are no longer insured, impacts can spill over into the rest of the system. Our role is not to tell insurers how to underwrite. Rather it is to understand and monitor these interlinkages while promoting proportionate safety and soundness, and innovation. Both of which are directly relevant to the PRC and FPC.

As we make progress across each of these areas, it helps to embed climate-risk assessment into everyday practice across the Bank. But there are also important feedback loops too. More effective supervision – clearer governance, better data, improved modelling and decision‑useful scenario practice – will help support our system-wide risk monitoring. Likewise, our work to manage our own climate exposures helps shape the climate scenarios we use. And our efforts to improve the quantification of macroeconomic impacts of climate change can refine the questions we ask of ourselves, as policymakers, and as supervisors, of firms.

Of course, as the impact of climate evolves - so too will our thinking – especially as we look to also learn from the experience of others, drawing on expertise including across climate science and economics.

My main message today is that we’re doing the work and analysis to understand the impacts of climate on our mandate and we’re working out how to respond to it. We’re increasingly learning from others and our plan is to “Measure, Model, Tackle, Tailor”.

In doing so, we’re not going beyond our mandate, we’re making sure we achieve it.

We’re not trying to shape the path of climate transition policies; that’s for elected officials.

But if climate shocks and the transition affect the economy and financial system, then we need to understand their impacts, just like any other shock. In doing so, we can make sure that the financial system remains stable and that price stability is maintained. That is the best contribution that we can make to the climate transition.

I would like to thank Fergus Booker for his excellent assistance in writing this speech. I would also like to thank Caspar Siegert, Lukasz Krebel, Hannah Copeland, Dooho Shin, Boromeus Wanengkirtyo, Eleanor Fielding, Will Banks and Harriet Richards for their underlying research and helpful input. I would also like to thank Andrew Bailey, Sarah Breeden, David Bailey, Danae Kyriakopoulou and Tim Rawlings for their helpful comments.