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IMF Country Report No. 22/102
UNITED KINGDOM
FINANCIAL SECTOR ASSESSMENT PROGRAM
SYSTEMIC STRESS, AND CLIMATE-RELATED FINANCIAL RISK: IMPLICATIONS FOR BALANCE SHEET RESILIENCE
April 2022
This Financial Sector Assessment Program paper on United Kingdom was prepared by a staff team of the International Monetary Fund. It is based on the information available at the time it was completed on March 18, 2022.
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Title page
UNITED KINGDOM
FINANCIAL SECTOR ASSESSMENT PROGRAM
March 18, 2022
TECHNICAL NOTE
SYSTEMIC STRESS, AND CLIMATE-RELATED FINANCIAL RISKS: IMPLICATIONS FOR BALANCE SHEET RESILIENCE
Prepared By
Monetary and Capital Markets Department
This Note was prepared by IMF staff in the context of an IMF Financial Sector Assessment Program (FSAP) in the United Kingdom. The FSAP was led by Mr. Udaibir Das. The note contains technical analysis and detailed information underpinning the FSAP’s findings and recommendations. Further information on the FSAP can be found at http://www.imf.org/external/np/fsap/fssa.aspx
Contents
Glossary
EXECUTIVE SUMMARY AND RECOMMENDATIONS
INTRODUCTION
ADVERSE SCENARIOS
NONFINANCIAL CORPORATIONS
A. Development of Nonfinancial Corporate Balance Sheets
B. Empirical Determinants of Corporates’ Financial Vulnerabilities
C. Stress Analysis
D. Financial Sector Exposures to NFCs’ Vulnerabilities
HOUSEHOLDS
A Development of Household Balance Sheets
B. Empirical Determinants of Household Debt-at-Risk
C. Stress Analysis
D. Financial Sector Exposures to Households’ Vulnerabilities
BANK SOLVENCY STRESS TEST
A Credit Risk Modelling Approach
B. Market Risk Modelling Approach
C. Modelling of P&L Components
D. Solvency Stress Tests Results
E. Fintech Overlay
F. Macro-Financial Feedback Effects
BANK LIQUIDITY STRESS TEST
INSURANCE STRESS TEST
A. Scope and Sample of the Solvency Stress Test
B. Scenarios for the Solvency Stress Test
C. Capital Standard and Modeling Assumptions
D. Results of the Solvency Stress Test
E. Liquidity Risks
F. Recommendations
CLIMATE-RELATED VULNERABILITIES
A. Transition Risk
B. Physical Risk
C. Recommendations
BOXES
1. The Importance of Data in Support of Financial Stability Monitoring and Analysis
2. NGFS Scenarios
3. The GTAP-E Model and Its Role in the Transition Risk Analysis
4. The Climate Credit Analytics Model Suite
5. Transition Risk in the Pension Fund Sector
6. Buildings’ Energy Efficiency in the United Kingdom
7. Flood Re
FIGURES
1. Macrofinancial Indicators
2. Systemic Adverse Scenarios. Paths Key Variables
3. Banking System Performance
4. Macroprudential Solvency Stress Tests: A Block Diagram
5. Projected PDs under Scenarios
6. Corporate Stress Test vs. Satellite Models
7. Projected LGDs Under Scenarios
8. Projected P&L Components under Scenarios
9. Bank Solvency Stress Test Results
10. Bank Solvency Stress Test Results. Cumulative Decomposition 2020–2025
11. Bank Solvency Stress Test Results. Link to Corporate Stress Test
12. Fintech Overlay
13. Macro-Financial Feedback Effects Diagram
14. Macro-Financial Feedback Effects
15. Insurers’ Balance Sheets and Fixed-Income Portfolios
16. Own Funds and Solvency Capital Requirement
17. Insurers’ Derivative Holdings
18. Insurance Stress Test—Impact on Assets and Liabilities
19. Insurance Stress Test—Impact on Solvency Ratios
20. Insurance Sensitivity Analysis
21. Insurance Liquidity Stress Test Results
22. The Logic of the Climate Minsky Moment
23. Impact on Asset Valuations at the Climate Minsky Point
24. Climate Transition Risks in Insurance
25. Carbon price paths for analysis of transition risk in U.K. residential mortgages
26. Impact of Carbon Prices on Residential Properties’ Valuation via Energy and Energy Efficiency Costs
27. Insurers’ Exposures to Physical Climate Risks
28. Physical Climate Risks in Insurance
TABLES
1. Recommendations
2. Costs of Coronavirus Job Retention Scheme
3. Guaranteed Loans vs. MFIs Net Lending
4. Corporate Profit Regression – Default on Bank Loans
5. Household Regressions
6. Credit Risk Models
7. P&L Models
8. Insurance Stress Test Specification
9. Methodological Approaches for Climate Risk Analysis
10. Insurance Sectoral Investment Exposures
ANNEXES
I. Risk Assessment Matrix
11. Dynamics of Corporate Balance Sheets
III. Banking Sector Stress Test Matrix
IV. Liquidity Stress Test—Assumptions
V. Insurance Sector Stress Testing Matrix
VI. Insurance Interest Rate Scenarios
VII. Integration of Models for Transition Risk Analysis and Mapping to Financial Institutions’ Credit and Market Losses
Glossary
| AC | Amortised Cost |
| ACS | Annual Cyclical Scenario |
| AFS/FVO | Available for Sale/Fair Value Option |
| AIFMD | Alternative Investment Fund Managers Directive |
| AM L/C FT | Anti-Money Laundering/Combating the Financing of Terrorism |
| AT1 | Additional Tier 1 |
| BAU | Business As Usual |
| BES | Biennial Exploratory Scenario |
| BIS | Bank for International Settlements |
| BMA | Bayesian Model Averaging |
| BOE | Bank of England |
| CAR | Capital Adequacy Ratio |
| CCA | Climate Credit Analytics © |
| CCB | Capital Conservation Buffer |
| CCP | Central Counterparty |
| CCyB | Counter-Cyclical Capital Buffer |
| CDR | Carbon Dioxide Removal |
| CEO | Chief Executive Officer |
| CET1 | Common Equity Tier 1 |
| CIB | Corporate and Investment Banking |
| CJRS | Coronavirus Job Retention Scheme |
| CO 2 | Carbon Dioxide |
| COREP | Common Reporting Framework |
| CPI | Consumer Price Index |
| CRE | Commercial Real Estate |
| CS01 | Risk of Spread Over the Benchmark Rate Moving By 1 Basis Point. |
| CSD | Central Security Depository |
| CVA | Credit Value Adjustment |
| DEFRA | Department for the Environment, Food and Rural Affairs |
| DNZ | Divergent Net Zero (scenario) |
| DtD | Distance to Default |
| DV01 | Risk of The Risk-Free/Benchmark Rate Moving 1 Basis Point |
| EAD | Exposure At Default |
| ECL | Expected Credit Loss |
| EDF | Expected Default Frequency |
| EIOPA | European Insurance and Occupational Pensions Authority |
| EPC | Energy Performance Certificate |
| ESMA | European Securities and Markets Authority |
| ETF | Exchange Traded Fund |
| EU | European Union |
| FATF | Financial Action Task Force |
| FCA | Financial Conduct Authority |
| FCFE | Free Cash-Flow to Equity |
| FINREP | Financial Reporting |
| FMIs | Financial Market Infrastructures |
| FPC | Financial Policy Committee |
| FRF | Future Regulatory Framework |
| FSAP | Financial Sector Assessment Program |
| FSB | Financial Stability Board |
| FSCS | Financial Services Compensation Scheme |
| FSMA | Financial Services and Markets Act 2020 |
| FSR | Financial Stability Report |
| FSSA | Financial System Stability Assessment |
| FVA | Fair Value Accounting |
| FVOCI | Fair Value through Other Comprehensive Income |
| FVPL | Fair Value through Profit and Loss |
| FX | Foreign Exchange |
| GAAP | Generally Accepted Accounting Principles |
| GBP | British Pound |
| GDP | Gross Domestic Product |
| GFC | Global Financial Crisis |
| GFM | Global Macro Financial Model |
| GMST | Global Mean Surface Temperature |
| G-SIB | Global Systemically Important Bank |
| GTAP-E | Global Trade Analysis Project – Energy/Environment version |
| GVA | Gross Value Added |
| HMT | Her Majesty’s Treasury |
| HQLA | High Quality Liquid Assets |
| IAIS | International Association of Insurance Supervisors |
| IAM | Integrated Assessment Model |
| ICP | Insurance Core Principle |
| IFRS | International Financial Reporting Standards |
| IM | Initial Maturity |
| IMF | International Monetary Fund |
| IOSCO | International Organization of Securities Commissions |
| IRRBB | Interest Rate Risk in the Banking Book |
| KA | Key Attributes of Effective Resolution Regimes for Financial Institutions |
| LCR | Liquidity Coverage Ratio |
| LGD | Loss Given Default |
| LME | London Metal Exchange |
| LTG | Long-Term Guarantee |
| LTV | Loan to Value |
| MA | Matching Adjustment |
| ML/TF | Money Laundering/Terrorism Financing |
| MMF | Money Market Fund |
| MoU | Memorandum of Understanding |
| MPC | Monetary Policy Committee |
| MTM | Mark-to-Market |
| MVA | Market Value of Assets |
| MVE | Market value of Equity |
| NACE | Nomenclature statistique des Activités économiques dans la Communauté Européenne (Statistical Classification of Economic Activities in the European Community) |
| NBFI | Non-Bank Financial Institutions |
| NDCs | National Determined Contributions |
| NFC | Non-Financial Corporates |
| NGFS | Network for Greening the Financial Sector |
| NPL | Non-Performing Loan |
| NPLR | Non-Performing Loan Ratio |
| NPV | Net Present Value |
| NZ2050 | Net Zero by 2050 (scenario) |
| OB | Open Banking |
| OPBAS | Office of Professional Body Anti-Money Laundering Supervision |
| ORSA | Own Risk and Solvency Assessment |
| O-SII | Other Systemically Important Institutions |
| OTC | Offshore Trade Center |
| P&L | Profit and Losses |
| PBS | Professional Body Supervisor |
| PD | Probability of Default |
| PiT | Point-In-Time |
| PNFC | Private Non-Financial Corporation |
| PRA | Prudential Regulation Authority |
| PRC | Prudential Regulation Committee |
| PVA | Present Value |
| QRT | Quantitative Reporting Template |
| RAF | Resolvability Assessment Framework |
| RAM | Risk Assessment Matrix |
| RBB | Risks Beyond Banking |
| RCP | Representative Concentration Pathway |
| RFRs | Risk Free Rates |
| RHI | Renewable Heating Incentive |
| RLF | Resolution Liquidity Framework |
| RRP | Recovery and Resolution Plan/Planning |
| RWA | Risk Weighted Assets |
| SCR | Solvency Capital Requirement |
| SEC | U.S. Securities and Exchange Commission |
| SMEs | Small and Medium-Sized Enterprises |
| SOA | Systemic Oversight Assessment |
| SRA | Systemic Risk Analysis |
| SRB | Systemic Risk Buffer |
| STeM | Stress Test Matrix |
| SVAR | Structural Vector Auto Regression |
| TCA | Trade and Cooperation Agreement |
| TFP | Total Factor Productivity |
| TMTP | Transitional on Technical Provisions |
| TPR | The Pensions Regulator |
| TTC | Through-The-Cycle |
| U.K. | United Kingdom |
| VAR | Vector Auto Regression |
| WEO | World Economic Outlook |
| y-o-y | Year-on-Year |