NYDFS Proposes Guidance for Banks to Manage Climate-related Risk

The New York Department of Financial Services ("NYDFS") proposed guidance for state-regulated banking and mortgage institutions (collectively, "Institutions") on managing safety and soundness risks related to climate change.

In the guidance, NYDFS said that Institutions should manage climate-related financial risks in a manner "proportionate" with, and calibrated to, each Institution's exposure to such risks. NYDFS emphasized that the climate-related financial risks faced by an Institution may vary depending on the Institution's size, complexity, geographic distribution, investment strategies and available resources to manage risk. NYDFS also encouraged Institutions to consider the disproportionate impact that climate change would have on low- and moderate-income and minority communities to ensure that Institutions can continue to provide fair lending while mitigating climate risk.

Among other areas, the guidance addresses the following issues:

• Corporate Governance. NYDFS expects an Institution's corporate governance framework to ensure that (i) there are internal processes for "identifying, measuring, monitoring and controlling" the Institution's climate-related financial risks and (ii) that the Institution's board and management have "adequate understanding and knowledge to assess climate-related financial risks and their impact on the overall risk appetite of the organization." The proposed guidance includes processes for evaluating the potential impact of climate-related financial risks on businesses and their environments in the short, medium and long term. Further, NYDFS emphasizes that risk mitigation strategies for climate-related financial risk "should align with and support the [Institution's] broader strategy, risk appetite and risk management framework." According to the guidance, an Institution's policies, procedures and controls across its relevant functions and business units should be modified to "reflect the distinctive nature of climate-related financial risks and changes, if any, to an [Institution's] activities."

• Internal Control Framework. NYDFS would require Institutions to revise their internal control frameworks to incorporate climate-related financial risks within their risk-taking, risk management and internal audit lines of defense. Such incorporation includes, among other things, (i) taking climate-related financial risks into consideration during client onboarding and credit review processes; (ii) initiating independent climate-related financial risk evaluations; and (iii) establishing regular independent reviews of an Institution's climate-related internal control framework "in light of changes in the methodology, business model and risk profile of the [Institution], as well as in the quality of the underlying data."

• Risk Management Process. Under the proposed guidance, Institutions should utilize their existing risk management frameworks to evaluate and control climate-related financial risks. This includes identification of the drivers of climate-related financial risk at the "transaction, portfolio, and entity. . . level(s), as appropriate." NYDFS states that larger Institutions should have the board and senior management identify the potential impact of climate-related financial risks on "interdependencies and correlations across portfolios and lines of business." In addition, the proposal requires Institutions to assess the impact of climate risks, including physical and transition risks, on existing risk categories such as credit risk, market risk, operational risk, liquidity risk, legal and compliance risk and strategic risk.

• Scenario Analysis. NYDFS emphasizes that Institutions should "consider using a range of climate scenarios based on assumptions regarding impact of climate-related financial risks over different time horizons to assess the resiliency of their business models and strategies, identify and measure vulnerability to relevant climate-related risk factors, including physical and transition risks, estimate exposures and potential impacts and determine the materiality of climate-related financial risks."

NYDFS requested feedback on the proposed guidance, and in particular on questions such as: (i) whether a timeline for implementation should be established; (ii) what proportionate scenario analysis looks like for smaller Institutions; (iii) whether there are other aspects of climate-related financial risks that the proposed guidance should consider; and (iv) whether existing regulatory reporting requirements applicable to Institutions should be amended to include exposure to material climate-related financial risks and management of such risks.

Feedback on the proposed guidance is due by March 21, 2023.