Bank Regulators Issue Guidance on Managing Climate Risk
Commentary by Steven Lofchie
The OCC, the FDIC and the Federal Reserve Board (collectively, the "Banking Agencies") finalized guidance for senior management of large banks on managing exposures to climate-related financial risks.
The Banking Agencies highlighted the following principles for financial institutions with over $100 billion in total consolidated assets:
- Governance. Boards of financial institutions must understand the effects of climate-related financial risks in order to supervise their respective institution's business strategy, risk management and risk appetite. Management personnel should be responsible for executing their financial institution's risk management framework and report to the board the "level and nature" of risks facing their financial institution.
- Policies. Management should incorporate climate-related financial risks into policies that reflect (i) the "distinctive characteristics" of such risks and (ii) a financial institution's operating environment and activities.
- Strategic Planning. Institutions should address climate-related financial risk exposures over various time horizons.
- Risk Management. Management should oversee the development of processes to identify and monitor climate-related financial risks within a financial institution's existing framework, using tools such as exposure analysis, heat maps, climate risk dashboards and scenario analysis.
- Data and Reporting. Management should incorporate climate-related financial risk information into internal reporting and escalation processes to support timely decision-making.
- Scenario Analysis. Management should implement scenario analysis frameworks consistent with a financial institution's size, complexity, business activity and risk profile.
Statements
FDIC Chair Martin J. Gruenberg emphasized the importance of recognizing that climate change "should not be viewed solely as a longer-term consideration" and that while the banking industry has handled climate events relatively well, "there is potential for past mitigation strategies to become less effective."
FDIC Vice Chair Travis Hill said that although the probability of climate-related risks resulting in bank failures is not zero, that does not "justify elevating climate above a range of other risks banks face."
FDIC Board Director Jonathan McKernan stated that the "singular focus" on one emerging risk type "exposes the real intent and effect" of the guidance, which is for "U.S. bank regulators to follow the lead of their European counterparts in pushing banks to facilitate a transition to a lower carbon economy." He made clear that regulators' involvement in policy decisions will "just further politicize the bank regulators."
CFPB Director Rohit Chopra said that regulators should build on the principles over time and provide more detail. He urged bank regulators to provide further guidance to small banks on climate-related risks.
Acting Comptroller of the Currency Michael J. Hsu warned of the increased frequency and severity of extreme weather events. He said that the principles promote safety and soundness by highlighting the risk management capabilities that large banks need to develop as the world changes.
Commentary
It is hard to know what to do with advice that banks should create "heat maps" and "climate risk dashboards" when the inputs cannot be quantified and are not agreed upon. Perhaps another way of approaching the issue is to say that banks must manage certain political risk. That is, the risk of laws and regulations changing to promote or disfavor certain industries, whether the industry is energy products or housing or pharmaceuticals.
There is also the issue of how this guidance might be enforced. Will the Banking Agencies challenge a particular bank's estimation of its risk to climate impacts? Or of a bank's estimate of the risk on the businesses of the bank's customers? Might the guidance push banks away from lending in California, for example, in light of the impact that climate change is having on the state, according to the state's leaders?
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The OCC issued draft Principles for Climate-Related Financial Risk Management for Large Banks.
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The FDIC is seeking comments on draft principles aimed at large financial institutions, defined as those that have over $100 billion in total consolidated assets.
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The Federal Reserve Board requested comment on draft "Principles for Climate-Related Financial Risk Management for Large Financial Institutions."