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February 6, 2023

The Fed Begins to Tackle Climate Change Risks Building Up in Big Banks

Better Markets filed a comment letter in response to the to the Federal Reserve’s draft Principles for Climate-Related Financial Risk Management for Large Financial Institutions.

Why It Matters. Climate change is a serious, multi-faceted, and unprecedented threat to the nation, and financial institutions, including banks, are not exempt from this threat.  If Fed-supervised banks are not prepared to grapple with the physical or transition risks of climate change, the Fed will have failed in its job to protect the stability of the nation’s financial system. The Fed’s draft principles are an important first step in fulfilling that task by laying out guidance to many of the largest banks on how to mitigate climate-related risks.

What We Said. The Fed is catching up to the FDIC and OCC, which have already issued similar principles for the institutions under their authority, and we commend the Fed for doing so. We also welcome the Fed’s general approach of integrating climate risks into existing risk management principles with several additions that capture unique aspects of climate-related risks. The Fed has also rightly emphasized the differences in responsibilities of boards and senior management, with special emphasis on boards being ultimately accountable for climate risk issues that arise. We therefore urge the Fed to move ahead with a final version of its principles.

That said, there are several ways in which the Fed could enhance the current draft principles. First, banks should be expected to look to available, internationally agreed-upon best practices for measuring and managing climate-related risks to their financial positions and operations.  Second, banks should also be expected to use widely accepted best practices in scenario analysis of climate change risks; this would generally mean use of plausible scenarios with minimum levels of severity and consideration of systemic impacts. Third, the reasons behind the Fed’s principles aren’t unique to big banks, so the Fed should consider extending these principles to smaller, regional banks as well.

Finally, as we have said before, guidance from the Fed and other bank supervisors should not be toothless.  It must instead have some real effect in the examination process, and the Fed should ensure that it does not hamstring these new draft principles on climate risk in the same manner it has for other guidance. In fact, the Fed should undo this type of error in some of its past regulatory actions.

Bottom Line. Climate change cannot be ignored, even by the largest, most profitable banks. The Fed has taken a strong first step to ensure the banking system does not keep its head in the sand, and we call for it to maintain its momentum with even more robust principles for managing climate-related risk.

Read our full Comment Letter here or click the button below.

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