Bank of England Embeds Climate Risk Into Core Monetary & Financial Stability Framework

Key Takeaways

• Climate Integrated Across Mandate: The Bank of England is embedding climate considerations into monetary policy, financial stability oversight and prudential supervision.
• Supply Shock Dynamics: Physical climate events and transition policies can act like supply shocks, pushing inflation higher and weighing on output within the monetary policy horizon.
• Repricing Risk: The Bank has warned that a sudden market reassessment of climate risks could create financial stability concerns, particularly for non-bank institutions.
• Supervisory Implementation: Updated supervisory expectations under Supervisory Statement 5/25 require firms to integrate climate risk into governance, risk management and scenario analysis frameworks.
• Balance Sheet Measures: The Bank has adjusted collateral haircuts and eligibility criteria and continues to publish climate-related disclosures aligned with the Task Force on Climate-related Financial Disclosures framework.

Deep Dive

Climate risk is no longer a theoretical overlay in central banking. It is becoming embedded in the day-to-day mechanics of monetary policy, supervision and financial stability. That is what James Talbot, Executive Director for International at the Bank of England, said while speaking at the London School of Economics. Talbot, who also chairs the monetary policy work-stream at the Network for Greening the Financial System, set out how the Bank is integrating climate considerations across its core objectives.

Talbot opened by acknowledging that climate change has traditionally been treated as a long-run issue. Scientists have examined it for decades, and governments have pursued mitigation policies for more than twenty-five years. Central banks, by contrast, are relative newcomers.

The Bank of England began its climate work roughly twelve years ago, initially focused on insurance sector risks. Nine years ago, it became one of eight founding members of the Network for Greening the Financial System, which now includes around 150 institutions worldwide.

Today, climate considerations sit squarely within the Bank’s statutory mandate. Global temperatures have averaged more than 1.5 degrees above pre-industrial levels over the past three calendar years, and the frequency and intensity of extreme weather events have increased. As those shocks feed through to food prices, energy markets and supply chains, they move from the abstract into the monetary policy horizon.

For the Monetary Policy Committee, whose primary objective is price stability, that shift matters.

Climate Shocks And Monetary Policy Trade-Offs

Talbot described two primary transmission channels through which climate affects the macroeconomy.

Physical risks (such as floods, storms and heatwaves) can disrupt production and trade, pushing inflation higher while weighing on output. These resemble classic supply shocks.

Transition policies, including carbon pricing and regulatory changes, can drive sustained relative price movements, shift investment patterns and reallocate production across sectors.

He cited research from the European Central Bank showing that the extreme heat of summer 2022 contributed 0.7 percentage points to annual food price inflation and 0.3 percentage points to headline inflation in Europe.

Bank of England modelling suggests that a 7 percent rise in the UK carbon price would increase energy consumer price inflation by around 1 percentage point after one year, followed by a smaller but more persistent rise in non-energy inflation. GDP would fall temporarily roughly two years after the initial shock.

Such developments present familiar policy dilemmas. If shocks are temporary, the Monetary Policy Committee may look through first-round effects. If they become more frequent or persistent, policymakers may need to respond more forcefully to prevent second-round inflationary pressures.

Talbot noted that repeated supply shocks in recent years, largely geopolitical in origin, have already highlighted the importance of understanding supply-side dynamics. Climate shocks, he suggested, belong firmly in that category.

Through the Network for Greening the Financial System, more than sixty central banks have collaborated on conceptual frameworks and modelling approaches to assess climate’s macroeconomic impact. A forthcoming publication will examine how climate considerations affect monetary policy strategy.

Financial Stability And The Risk Of Repricing

The Bank’s financial stability work is more advanced.

The 2021 Climate Biennial Exploratory Scenario was a first step in quantifying long-term climate-related risks to the UK financial system. It found that an orderly transition would keep system-wide costs lower than delayed or disorderly pathways.

More recently, the Bank has examined the possibility of a sudden reassessment of transition or physical risks, sometimes referred to as a climate “Minsky moment.” In its December 2025 Financial Stability Report, it warned that a sharp repricing of climate risk could expose non-bank financial institutions to material losses and amplify stress through market dynamics.

Insurance represents another critical channel. Around 6.3 million properties in England are currently in flood-risk areas, a number projected to rise to about 8 million by mid-century. While the Flood Re scheme currently supports affordability and availability of insurance, it is due to end in 2039. Over time, rising physical risks could translate into higher premiums, lower property values and increased credit losses for banks.

In response, the Bank is integrating climate risk assessment into routine financial stability monitoring and investing in improved data collection and scenario analysis.

Supervision Moves From Principles To Implementation

Supervision remains the most developed strand of the Bank’s climate work.

In 2019, the Prudential Regulation Authority issued Supervisory Statement 3/19, setting expectations that banks and insurers treat climate change as a financial risk subject to governance, risk management and disclosure standards.

Following consultation in April 2025, the Bank published updated expectations in December 2025 under Supervisory Statement 5/25. The revised framework is proportionate and risk-based, recognising that climate risk exposure varies by firm size, geography and business model.

Talbot stressed that scenario analysis should be decision-useful rather than a compliance exercise. Firms are expected to embed climate risk within existing governance and risk management structures, with clear senior ownership and board-level oversight.

The Bank and the Financial Conduct Authority continue to co-convene the Climate Financial Risk Forum to support industry capability building through practical guidance and tools.

Managing The Bank’s Own Climate Exposure

Talbot also highlighted steps taken to manage climate-related risks on the Bank’s own balance sheet.

The Bank has increased haircuts and tightened eligibility criteria for certain mortgage-loan collateral in its lending operations, including considerations linked to energy efficiency standards and flood risks. These measures now cover more than three-quarters of collateral underpinning lending in the Sterling Monetary Framework.

The Bank also publishes an annual climate-related financial disclosure aligned with the Task Force on Climate-related Financial Disclosures framework, covering governance, strategy, risk management and metrics, including its roughly £500 billion sovereign bond holdings.

Embedding Climate Into Business As Usual

Talbot’s overarching message was that the foundational work is largely complete. The priority now is integration.

For monetary policy, that includes more systematic use of scenarios, consistent with recommendations from the Bernanke review of forecasting at the Bank. As modellng improves, climate-related insights could increasingly inform policy calibration.

For financial stability, the focus is on deeper data collection, targeted analysis and potential incorporation of climate exposures into regular stress testing frameworks.

Across supervision, implementation and capability building are central. Climate risk is expected to be treated like any other operational or financial risk, managed through existing governance structures.

Talbot closed by drawing a clear boundary. The Bank is not setting climate policy. That responsibility lies with elected officials. But if climate shocks and transition dynamics affect inflation, growth or financial resilience, then they fall squarely within the Bank’s mandate.

By measuring, modeling, tackling and tailoring its response, the Bank aims to ensure that price stability and financial stability are maintained in an era where climate risk is no longer confined to the long run.

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