UK Financial Regulator Mandates Comprehensive Climate Risk Management Overhaul for Banks and Insurers

The United Kingdom’s Prudential Regulation Authority has fundamentally reshaped climate risk expectations for financial institutions with the publication of Supervisory Statement 5/25 (SS5/25) on December 3, 2025. This comprehensive regulatory update, which immediately replaced SS3/19 in its entirety, represents the most substantial tightening of climate-related financial risk management requirements for UK banks and insurers since the original framework was introduced over six years ago.

The PRA’s move from raising awareness to mandating embedded, systematic climate risk management reflects regulatory frustration with uneven progress across the financial sector. According to the accompanying Policy Statement PS25/25, while “firms have made progress in developing climate risk capabilities…progress remains uneven.” The regulator makes clear that the majority of banks and insurers have not done enough to evaluate and mitigate their climate-related risks, despite having six years since the original supervisory statement to develop appropriate frameworks.

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Immediate Implementation with Six-Month Review Requirement

Unlike typical regulatory changes that allow extended implementation periods, SS5/25 took effect immediately upon publication. However, the PRA has clarified that firms have six months from December 3, 2025—until June 3, 2026—to conduct comprehensive internal reviews of their current status against the updated expectations and develop credible action plans to address identified gaps.

Critically, this six-month period is not an implementation timeline but rather a structured review and planning phase. Firms are not expected to close all identified gaps within six months, but they must complete gap analyses and establish ambitious, credible remediation plans. PRA supervisors may request evidence of these internal reviews and action plans, though not until after the June 2026 deadline has passed.

The regulator emphasized that this approach reflects its expectation that firms take “a forward-looking, strategic and ambitious approach to managing climate-related financial risk on an ongoing basis.” This language signals that mere compliance box-ticking will be insufficient; the PRA expects substantive capability building and genuine integration of climate risk into core business operations.

Proportionality Principle Anchors Regulatory Approach

A central feature of SS5/25 is its emphasis on proportionate application of expectations, acknowledging that climate risk management requirements should reflect firms’ actual exposure levels, size, and complexity. The supervisory statement introduces a two-step process for identifying, determining, and understanding climate-related risks to inform appropriate risk management responses.

Step one requires firms to identify material climate-related risks they face and understand how these will impact business model resilience over relevant time horizons and under different climate scenarios. Crucially, boards must review and formally agree on material climate-related risks identified, recording them in risk registers with agreed timelines for future board review. This requirement elevates climate risk to the same governance status as other material financial risks.

Step two mandates that firms’ risk management responses be proportionate to assessed climate-related risk profiles. Firms determining that less sophisticated tools are appropriate must document their rationale, understand tool limitations, and adopt prudent interpretive approaches when informing decision-making. However, all firms must “remain vigilant to increases in the proximity, likelihood and scale of climate-related risks and continue to develop their risk management capabilities accordingly.”

This proportionality framework means that firms materially exposed to climate-related risks will need to take substantially greater action than less-exposed institutions. The PRA has been explicit that simply being a small firm does not automatically mean minimal climate risk—exposure must be assessed based on actual business activities, geographic footprints, and portfolio compositions.

Governance and Board Accountability Elevated

SS5/25 places unprecedented emphasis on board-level understanding, oversight, and accountability for climate-related risks. The supervisory statement mandates that boards must understand impacts of climate-related risks—including both transition and physical risks—under different climate scenarios and time horizons, and address these risks effectively in overall business strategy and risk appetite.

Boards are expected to periodically review and agree on material climate-related risks identified in risk registers, establishing criteria that trigger early reviews when circumstances change. The PRA expects firms to define and assign clear responsibilities across boards, sub-committees, and management bodies. A sufficiently senior individual must have designated responsibility for identifying and managing climate-related risks, reflected in that person’s statement of responsibilities and remuneration package.

Perhaps most significantly, board members will require dedicated training to understand the PRA’s updated expectations and build relevant skills and experience. This training obligation recognizes that effective climate risk governance cannot rely on delegation alone—board members themselves must possess adequate understanding to make informed decisions and provide effective challenge as climate-related risks evolve.

The governance expectations extend to management information systems as well. Boards must receive relevant management information supporting decision-making processes, with clear understanding of how climate scenario analysis outputs inform this information. Risk appetite and associated metrics and limits must cascade throughout organizations, including to business lines, ensuring that climate risk management is embedded across all operations.

Risk Management Framework Integration Requirements

The supervisory statement mandates regular risk assessments to identify material climate-related risk exposure and understand effects on business model resilience over different time horizons and climate scenarios. Assessment frequency for climate-related risk appetite, management practices, and strategy should align with reviews of risks of similar materiality, with trigger criteria in place for ad hoc reviews when climate-related risks change.

A critical new requirement involves identifying and understanding “client, counterparty, investee and policyholder risk” with clear materiality criteria. This provision recognizes that climate risks often materialize through relationships and exposures rather than directly within firms’ own operations. Financial institutions must therefore look beyond their own balance sheets to understand how climate risks affect parties to whom they have exposure.

Incorporating climate-related risks into existing risk frameworks may require significant resource input. The PRA has acknowledged in PS25/25 that “firms should use their judgement to assess whether material climate-related risks should be incorporated into their existing risk register or within a supplementary sub-register.” This flexibility allows firms to structure their risk documentation in ways that make most sense for their specific circumstances, while ensuring appropriate board-level visibility.

Climate Scenario Analysis Sophistication Requirements

The complexity in constructing and implementing climate scenario analysis (CSA) represents a common challenge for firms, particularly in understanding and using outputs to inform and quantify exposure to climate-related risks. Many firms have struggled to develop adequate understanding of climate-related risks they face and to demonstrate that they appropriately account for these risks in decision-making and risk management.

SS5/25 establishes clear expectations that firms materially exposed to climate-related risk must undertake more sophisticated CSA than less-exposed institutions. Firms must run CSA with clearly defined objectives, documenting and demonstrating rationale for selected scenario ranges. Scenarios should be clearly defined, agreed by boards, and calibrated—including severity, time horizons, and frequency—in line with proportionality approaches.

Critically, firms must demonstrate how CSA results inform decision-making. This represents a significant evolution from treating scenario analysis as a compliance exercise toward using it as a genuine strategic planning tool. Multiple CSA exercises will be required for different objectives, recognizing that capital adequacy assessment, business strategy formulation, and risk management require different analytical approaches.

The supervisory statement also encourages consideration of reverse stress tests, identifying ranges of adverse climate events that would render business models unviable. This requirement aligns CSA with established stress testing methodologies while acknowledging the unique characteristics of climate-related risks, including their long time horizons, potential for non-linearity, and capacity to affect entire systems simultaneously.

Boards must understand CSA inputs, assumptions, design, outputs, application, and sources of uncertainty. They should review and update scenarios in line with modeling and scientific advancements and changing risk profiles. Importantly, boards must understand capabilities and limitations of models and toolkits being used, accounting for these when making decisions.

Data Challenges and Proxy Requirements

The supervisory statement directly addresses persistent data gaps that have hampered climate risk management. Firms must identify and assess data gaps, quantifying extent of uncertainty when setting risk appetite and developing risk management tools. While acknowledging that sustainability disclosure rules in the UK, Europe, and other jurisdictions may eventually provide needed data, the PRA notes that sustainability reporting remains in its infancy.

In the interim, firms must balance appropriate use of data from external suppliers with development of in-house capabilities over short and long terms. The PRA suggests that firms actively engage with clients, counterparties, investees, and policyholders to collect data—an interesting recommendation given current political pushback around data collection from small and medium-sized entities in contexts like the EU omnibus simplification package.

The supervisory statement clarifies that firms do not necessarily need to choose conservative proxies for inadequate, unreliable, or missing data, but proxies must be appropriate. This provision acknowledges that overly conservative assumptions could distort risk pictures as much as overly optimistic ones, while maintaining expectations that firms document and justify their proxy selections.

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Banking-Specific Capital and Liquidity Requirements

For banks specifically, SS5/25 establishes detailed expectations across multiple dimensions of prudential regulation. The supervisory statement emphasizes that climate-related risks must be appropriately reflected in Internal Capital Adequacy Assessment Processes (ICAAP), Internal Liquidity Adequacy Assessment Processes (ILAAP), and financial reporting—areas where the PRA has observed insufficient integration to date.

In financial reporting, banks must ensure timely capture of climate-related risks for financial reporting purposes, with clear responsibility and appropriate oversight within financial reporting functions. Practices and procedures must support assessment and measurement of climate-related risks in financial statements, ensuring relevant climate-related risk drivers are appropriately identified and assessed.

For expected credit losses (ECL), the PRA expects banks to recognize climate-related risk drivers and integrate them into ECL calculations. Firms should conduct periodic reviews of these processes, identifying data requirements needed to effectively factor climate-related risk drivers into loan-level and collective portfolio-level ECL estimates. This represents a significant challenge, as climate risks operate over longer time horizons than traditional credit risk models typically accommodate.

In ICAAP processes, the PRA has observed that many firms do not provide sufficient contextual information for supervisors to understand how physical and transition risks have been estimated. Banks must now demonstrate how climate-related risks have been incorporated and that they are adequately capitalized, with CSA serving as a key tool for capital adequacy assessments. This enables closer supervisory scrutiny of whether capital provisions properly reflect climate risk exposures.

For ILAAP assessments, banks must evaluate whether climate-related scenarios could cause cash outflows or deplete liquidity buffers under stressed scenarios. Evidence must demonstrate that material exposures included in risk registers are appropriately funded, with detail on methodologies, scenarios, assumptions, judgments, and proxies used.

Insurance-Specific Underwriting and Reserving Expectations

For insurers and reinsurers, SS5/25 establishes expectations for managing climate-related risks that might emerge over both long and short-term horizons to ensure exposures stay within chosen risk appetites. The PRA notes that climate-related risks could drive underwriting, reserving, market, credit, liquidity, and operational risks, as well as reputational and litigation risks, with potential for these to be interrelated, magnified, and increasing over longer time horizons.

In managing asset portfolios, insurers must consider risks on both sides of balance sheets and their interrelationships, ensuring that where assets back longer-term liabilities, they may be affected by sudden transition risks. Solvency II insurers should consider whether excessive accumulation of climate-related risk exists in portfolios, identifying mitigants if risk accumulation proves excessive.

For Own Risk and Solvency Assessments (ORSAs), climate-related risks should be integrated into risk models where material, with potential impacts of climate change including climate scenarios appropriately considered. Sufficient detail must be provided to enable PRA review of reasonableness of each action, with suitable trigger points identified for when planned management actions would occur.

In Solvency Capital Requirements (SCRs), insurers must reflect impacts of climate-related risks on underwriting, reserving, market, credit, and operational risks to ensure climate-related risk is not underestimated for capital purposes. This may require detailed changes to investment and underwriting models, including specification of metrics and indicators monitored to inform decisions.

For underwriting and reserving risk, non-life insurers must consider climate change impacts on natural catastrophe risk, recognizing that larger claims may be incurred than historical experience suggests. Adjustments should be made to models to reflect climate-related perils. Life insurers should consider climate change impacts on mortality and morbidity assumptions, accounting for increases in extreme weather events or respiratory and waterborne diseases.

Alignment with International Standards

SS5/25 represents the UK’s implementation of evolving international standards for climate-related financial risk management. The supervisory statement incorporates guidance from the Basel Committee on Banking Supervision’s Principles for the effective management and supervision of climate-related financial risks, published in June 2022, as well as International Sustainability Standards Board (ISSB) global climate disclosure standards.

These Basel Committee principles established international baselines for how banks should identify, monitor, and manage climate-related financial risks that could materially impair their financial condition. The principles emphasize that climate-related risks should be managed through existing risk management frameworks rather than as standalone risk categories, with scenario analysis serving as key tool for understanding potential impacts.

By aligning UK expectations with these international standards, the PRA facilitates more consistent approaches across jurisdictions while acknowledging that implementation details will vary based on local market structures and regulatory frameworks. This alignment also supports internationally active firms in developing coherent global approaches to climate risk management rather than managing fragmented, jurisdiction-specific requirements.

Nature-Related Risks on the Horizon

Although not specifically covered in SS5/25, the latest Remit and recommendations for the Financial Policy Committee dated November 26, 2025, indicates that government strategic economic strategy includes transition to a nature-positive economy. The letter recognizes that climate and nature crisis represents “the greatest long-term global challenge that we face,” stating that the Committee should “continue to consider the materiality of nature-related financial risks for its primary objective.”

This signals that firms may need to start considering and identifying nature-related financial risks and integrating these into risk management frameworks. Given that boards are required to consider all material financial risks as part of satisfying directors’ fiduciary duties, this arguably already forms part of governance obligations. Preparation for future nature-related risk reporting using frameworks such as the Taskforce on Nature-related Financial Disclosures (TNFD) would position firms ahead of likely future regulatory developments.

Practical Implementation Challenges and Costs

The PRA acknowledges that implementing SS5/25 will entail costs for firms, including expenses associated with gap analyses, system and process changes, and ongoing operational requirements. Initial costs include conducting comprehensive internal reviews comparing current practices against updated expectations, as well as changes to systems and approaches needed to meet new requirements.

Firms should provision for these direct expenses as well as increased ongoing costs. Indirect costs may arise if firms adjust portfolios based on improved assessment and management of climate-related risk, potentially resulting in changed lending volumes, reduced holdings in high climate-risk assets, and shifts in asset prices. While these portfolio adjustments represent business decisions rather than compliance costs per se, they flow from enhanced risk understanding driven by regulatory requirements.

The PRA recognizes that practices are evolving and that implementation will require ongoing effort and collaboration across industry groups to collectively develop and advance best practices. To support firms, the PRA intends to invite the Climate Financial Risk Forum (CFRF) to update, consolidate, and evolve its guidance and tools over time to reflect and support firms in meeting updated supervisory expectations.

Strategic Implications for Financial Services

The publication of SS5/25 marks a inflection point in UK financial regulation, moving climate risk from a sustainability topic to a core determinant of financial soundness. While SS3/19 allowed firms to begin building conceptual frameworks, the new supervisory statement sets precise expectations for data, models, assumptions, proxies, and supplier governance that demand substantive operational changes.

For many institutions, meeting SS5/25 requirements will necessitate significant investments in technical infrastructure, analytical capabilities, and governance processes. Board members will need dedicated time and training to develop climate literacy. Risk management teams will require new skill sets encompassing climate science, scenario modeling, and complex data analysis. Treasury and capital planning functions must integrate climate considerations into traditional financial metrics and processes.

Perhaps most significantly, SS5/25 requires that firms fundamentally rethink how they assess creditworthiness, price insurance, allocate capital, and plan strategy. Climate risks can no longer be treated as distant, uncertain possibilities to be monitored passively. They must be quantified, managed, and integrated into core business decision-making with the same rigor applied to traditional financial risks.

The supervisory statement’s emphasis on understanding data uncertainty, documenting assumptions, and justifying proxy selections reflects recognition that perfect climate risk quantification remains impossible. However, this uncertainty cannot justify inaction—firms must work with available information, acknowledge limitations, and maintain prudent approaches to interpretation and decision-making.

Conclusion and Path Forward

SS5/25 represents the most comprehensive climate risk management framework yet established for UK financial institutions. By combining clear expectations with proportionate application, the PRA has attempted to balance the need for consistent standards with recognition of firms’ varying risk exposures and capabilities. The immediate six months following publication will prove critical, as firms conduct gap analyses and develop remediation plans that supervisors will evaluate for credibility and ambition.

Financial institutions should act urgently to assess alignment with new expectations, identify gaps, mobilize resources to address deficiencies, and establish governance structures capable of providing ongoing oversight as climate risks and regulatory expectations continue to evolve. Those that treat SS5/25 as merely another compliance exercise risk falling behind competitors that recognize climate risk management as integral to long-term business sustainability and resilience.

The regulatory trajectory is clear: climate-related financial risks will receive increasing supervisory scrutiny, with expectations for sophistication, integration, and accountability rising steadily. Firms that build robust climate risk capabilities now will be better positioned not only to meet regulatory requirements but to navigate the physical and transition risks that climate change will increasingly impose on financial systems and the real economy they serve.

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By: Montel Kamau

Serrari Financial Analyst

12th January, 2026