Enhancing banks’ and insurers’ approaches to managing climate-related risks: four imperatives for the UK

The Earth Capital Nexus initiative sets out four essential priorities that will help build the UK’s financial resilience in the face of real-world climate risks.

The Prudential Regulation Authority’s (PRA) recent consultation, CP10/25, marks an important step in embedding climate risk within the UK’s financial supervisory framework. However, if the UK is to build its financial resilience to the threats to come and be positioned for long-term competitiveness, the supervisory framework must evolve further. Our response to CP10/25 identifies four key priorities to ensure that regulation reflects real-world risks — and supports UK firms in building resilience.

1. Set science-based principles for scenario analysis

Scenario analysis remains one of the most critical tools for assessing climate-related financial risks. But without clear expectations, it is underutilised and often misapplied. The PRA rightly avoids being overly prescriptive, but this can create paralysis, not innovation.

To be useful for decision-making, scenario analysis must move beyond static, stylised assumptions to reflect real-world volatility, abrupt policy shifts and compounding risks. Our work with firms during the 2021/22 Climate Biennial Exploratory Scenario (CBES) exercise of the PRA revealed major gaps: modelling capacity was limited, key physical and macro-financial risks were overlooked, and real-world shocks like supply chain breakdowns or concurrent policy shifts were excluded.

The PRA should therefore define a minimum set of principles and standards for scenario design. These should include:

• Incorporating at least one scenario of compounding shocks
• Ensuring tail-risks and tipping points are represented — not smoothed over
• Using both quantitative and narrative-based approaches to reflect uncertainty
• Building scenarios from national climate risk assessments, such as the UK Climate Change Risk Assessment (CCRA), to avoid missing material threats.

To give an example, our research shows that firms often miss major risks identified in the UK’s national climate change risk assessment — the UK CCRA — especially those linked to infrastructure, water systems and global supply chains — because scenarios rely on narrow modelling inputs. Tying expectations to national risk assessments would help close this gap and ensure a more grounded, proportionate risk analysis across the sector.

2. Address the regulatory blind spot on nature-related risks

Climate and nature risks are deeply interconnected. Yet CP10/25 remains largely silent on nature. Without meaningful regulatory action on both fronts, the UK financial system risks a dangerous underestimation of systemic exposure.

There are two important ways to look at nature in the context of the CP10/25 expectations:

(a) Firstly, ignoring nature fundamentally undermines climate risk assessment. If you’re not considering nature-related factors, then you’re not assessing your climate risks. Climate risks are neither linear nor isolated — they are deeply entangled with wider environmental risks. Our own research shows that nature-related feedback can amplify climate-related financial risks by a factor of two. For example, deforestation increases flood and heat risks, degraded soils amplify climate impacts on agriculture, and biodiversity loss can increase health risks. Our recent UK Nature-Related Financial Risk Assessment shows that excluding nature from analysis leads to systematic underestimation of risks across sectors including food, manufacturing, insurance and infrastructure.

This is not speculative. Our modelling indicates that nature degradation could cause GDP shocks of 9–18% across the world, and water scarcity alone could expose the UK economy to hundreds of billions in losses. These risks are not captured in existing PRA frameworks — despite evidence that they are both material and growing.

(b) Secondly, not including nature risks is inconsistent with the PRA’s statutory objectives. Under its primary objective to ensure safety and soundness of firms, the PRA must address all material sources of risk. Nature loss is now recognised globally as macro-critical by central banks, including by the European Central Bank and France’s ACPR. Domestically, our analysis has demonstrated material risks from soil degradation, water stress and ecosystem loss within UK borders and through its supply chain dependencies.

Under its secondary objective to support competitiveness and growth, the PRA must ensure UK firms are not left behind. International peers are already integrating nature risks into stress testing and supervision. The UK’s absence of guidance puts firms — and the country’s leadership in sustainable finance — at risk.

In short, nature is not an optional extra. It is foundational to both climate risk and financial stability. CP10/25 must be revised to include clear expectations that firms assess and manage material nature-related risks.

3. Provide clear guidance on timescales for scenario analysis

There is a well-documented misalignment between the short-term orientation of financial planning and the long-term dynamics of climate and nature-related risks. This short-termism undermines capital allocation, leads to underinvestment in resilience, and increases the likelihood of disorderly transitions and stranded assets.

The PRA should explicitly require:

• Use of long-term (10–20+ year) scenarios in capital planning and risk assessment
• Inclusion of late and abrupt policy scenarios, such as delayed carbon pricing or disorderly net zero transitions
• Transparency about inconsistencies between firms’ near-term investment strategies and their own long-term risk assumptions.

Without concrete expectations on time horizons, firms may continue to downplay structural risks that are well within the planning horizon of major investments and infrastructure.

4. Build sector-wide capability for robust risk assessment

Scenario development is complex, resource-intensive and can be inaccessible — especially for smaller firms. Many lack the modelling capabilities or data access to run sophisticated analyses. During CBES, some firms resorted to internal assumptions that made results incomparable or incomplete.

To improve consistency and lower the barriers to effective risk assessment, the PRA and Financial Conduct Authority should develop a Central Scenario Facility, which would provide:

• Modular scenario components for acute, chronic, transition and nature-linked risks
• Datasets aligned with supervisory expectations (e.g. UK hazard maps, transition pathways)
• Templates for internal risk analysis and regulatory submission.

This should be supported by an independent Scientific and Technical Advisory Group (STAG), helping ensure the latest science is rapidly and coherently translated into regulatory and market tools.

CP10/25 sets an important foundation — but must go further

Without action on nature, without clearer principles for scenario design, and without guidance on long-term risks, the UK financial system will remain exposed to blind spots and structural under-pricing of risk. By embedding scientifically grounded expectations and enabling firms to act, the PRA can deliver a more resilient, competitive and future-ready financial system.

Read the response in full, Submission to Bank of England consultation CP10/25 — Enhancing banks’ and insurers’ approaches to managing climate-related risks — Update to SS3/19.