Financial industry regulators have been warning about the climate change threat for years. Recently, however, the Biden administration’s view on how climate risk will affect regulators’ oversight of the U.S. financial system has come into much clearer focus.
In May, with an Executive Order, President Biden directed federal agencies to put in place the mechanisms that could assess the country’s economic vulnerabilities related to climate change and to begin crafting policies to address them. Then, according to The Economist’s “Could climate change trigger a financial crisis?” the White House issued a fact sheet detailing “six core pillars of its approach to combating climate risk. Those pillars include boosting the financial system’s resilience, protecting citizens’ savings and pensions, making the government’s procurement practices greener, incorporating climate risk in underwriting of government-backed mortgages, and building more resilient infrastructure.”
Many bankers, including those at many of the country’s largest institutions, have acknowledged that extreme weather events, a societal transition to cleaner energy, and other consequences of a warming planet pose significant business risks. At the same time, just how significant these risks are is up for debate, and many are concerned that climate regulations could burden their institutions with a number of new disclosure requirements, tie their hands when lending to certain industries, and even increase their capital requirements.
Back in early November, Board Governor Lael Brainard told American Banker that the Federal Reserve will subject financial institutions to “scenario analysis” of their climate-related risks. “Scenario analysis,” she said, “should help with risk identification and management as firms account for the physical risk of global warming, such as severe weather events, and the transition risk that will come from changing consumer behaviors and government policies. Although we should be humble about what the first generation of climate scenario analysis is likely to deliver, the challenges we face should not deter us from building the foundations now.”
Back on May 20th, the President issued Executive Order 14030, Climate-related Financial Risk. One of the main assignments given to financial regulators was a major report from the Financial Stability Oversight Council (FSOC). Led by agency heads across the government — a 15-member body of federal financial regulators, state regulators, an independent, President-appointed insurance expert, and chaired by Treasury Secretary Janet Yellen — FSOC was tasked with assessing the “climate-related financial risk to the U.S. economy.”
In response, the Council released its report, which as you can view here, focuses on the options that regulators have in incorporating climate risk into their supervision of the financial system. In it, Yellen says, “financial regulators, financial institutions, and investors need to have access to the best information and data to measure climate-related financial risks.” In it, are the Council’s recommended steps to be taken by member agencies, such as utilizing scenario analysis to evaluate the need for new regulations in assessing climate-related financial risk; enhancing climate-related disclosures for investors; improving the gathering of climate-related data for better risk management; and developing both the capacity and the expertise to ensure that climate-related financial risks are identified and managed. “These measures,” says Yellen, “will support the Administration’s urgent, whole-of-government effort on climate change and help the financial system support an orderly, economy-wide transition toward the goal of net-zero emissions.”
Some FSOC members have already taken action. The SEC has begun to develop more robust climate disclosures for publicly traded companies, including many of the nation’s largest banks. The Federal Reserve Board is focusing on developing a better understanding of climate-related risks and incorporating them into its supervision of financial firms. And, the Department of Housing and Urban Development, working alongside the Department of Veterans Affairs, the Agriculture Department, and Treasury, are working to modify their federal underwriting and lending program standards in order to better address climate-related financial risks to their loan portfolios.
Taking on the challenges that climate change poses to our financial security will take time and commitment. Climate change, and climate risk, present important implications (and opportunities) for banks who can get it right. According to Forbes, 73% of U.S. banks surveyed are already committed to managing climate risk and promoting the transition to a green economy. This, they believe, will help them attract both talent and customers.
So, where does this leave banks? Seems like a lot is being asked here; to do the job, at least in part, of agencies such as the IRS, the EPA, and the USPS. The climate is changing all right. The question is, are financial institutions warming up to the changes?
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