The reality of climate change is indisputable. Average global temperatures are rising, droughts are occurring in more locations and lasting longer and tropical storms are becoming more severe, all causing increased economic and personal damage. Without meaningful action, this is just the beginning. The fallout could be catastrophic to the economy and people’s livelihoods.
To date, banks have not been doing enough to manage and account for the risks of climate change or to support the transition towards a more sustainable economy. The Federal Reserve (the Fed) is best suited to meaningfully address climate change-related risks but has been woefully slow in doing so. The Fed must lead efforts related to banking supervision and regulation to address climate-related risks along with the Office of the Comptroller of the Currency (OCC), and Federal Deposit Insurance Corporation (FDIC). They should be using their authorities and expertise to monitor, assess and address both the micro-prudential (at each individual bank) and macro-prudential (across banks and the system) risks of climate change.
The mandates of the Agencies include promoting a strong banking system that can withstand severely adverse financial and economic outcomes as well as working to maintain financial stability, even as related to risks from climate change. These mandates set the bounds on what can be done to address climate change through financial regulation and supervision and on defining a defensible, lasting set of actions the Agencies could take.
Below are the actions Better Markets has identified that the Agencies could take:
Actions to Take for Bank Supervision
- Formally include climate risks in the supervisory process as well as in the determination of supervisory ratings
- Conduct supervisory (Fed-run) scenario analysis to identify climate-related risks and vulnerabilities; collaborate with international regulatory agencies
- Require banks to run scenario analysis to complement supervisory scenario analysis and identify weaknesses in banks’ climate risk management
- Collect detailed climate exposure and risk data
- Implement regular disclosures of climate exposures and risks as well as the results of supervisory and bank-run scenario analyses
Actions to Take for Bank Regulation
- Implement climate risk-related capital requirements through the supervisory stress test
- Consider increasing certain risk weights based on climate risks
- Implement a climate-related capital surcharge for systemically important financial institutions
- Implement restrictions to certain commodities activities and consider broader restrictions
Additionally, each of the largest banks has made public “commitments” to reduce their contributions to climate change. Many of these claims are either dubious and unlikely to materialize effectively or are efforts that were likely to materialize anyway. The banks’ commitments generally fall into one of three categories:
- Supporting and accelerating the transition to a low-carbon economy
- Identifying, sizing, and managing the climate risks in their portfolios and reducing those portfolio risks as well as the risks they pose to climate
- Improving the sustainability of their facilities and employee culture around sustainability
Without clear, sustained, and robust supervision and regulation from and by the Agencies there is no way to verify their claims or ensure that progress is made.
Climate change poses an existential threat to the global economy and financial system and may undermine the safety and soundness of the banking system. Based on available information, there is a substantial amount of climate-related exposure in the banking system. There is limited available exposure information about U.S. banks, but the European Central Bank estimates that the proportion of European banking system total exposures with current or projected physical risks is around 80% and that these exposures are concentrated in a few large banks.
The Fed, along with the other banking agencies, must act now to ensure the resiliency of our banking system and stability of the financial system as a whole in the face of climate change. The Fed is specifically charged with not just supervising the banking industry, but also doing what is necessary to maintain financial stability and limit financial crashes. The climate crisis materially threatens to impact every aspect of the economy and financial system, which means addressing climate risk is within the Fed’s mandate. The Fed—along with the other regulatory agencies and FSOC – has to start taking those threats seriously and acting accordingly and fast.