Tom Curry

U.S. and global financial regulatory authorities’ approaches to how climate change affects the safety and soundness of banks and the overall financial system are evolving. The primary objective of financial regulatory authorities generally is to maintain the safety and soundness of banks and the financial system.  

How, then, do regulators incorporate climate change risks into supervisory and financial stability assessments, financial reporting and regulatory capital frameworks? The range of risks has grown in recent years from traditional credit and liquidity risk to include less quantifiable risks associated with climate change. Both within the U.S. and internationally, financial regulators are answering the call at different speeds and with some policy differences.  

A consistent and uniform U.S. framework is developing after a relatively hands-off approach under the Trump administration. Following the Biden administration’s May 2021 executive order on climate-related financial risk, the Financial Stability Oversight Council, or FSOC, labeled climate change as an “emerging and increasing threat” to financial stability. Climate change has also triggered a political backlash as evidenced by the controversy surrounding presidential nominations, notably, Sarah Bloom Raskin’s recent withdrawal from consideration for the Federal Reserve’s vice chair for supervision.  

Kate Henry

Regulators Take Different Tacks 

While most financial regulatory agencies have representation in the FSOC, the organization tasked with identifying risks to the stability of the U.S. financial system, their individual responses vary. 

The Office of the Comptroller of the Currency released in December 2021 draft principles to identify and manage climate-related financial risks, with the goal of supporting efforts on climate-related financial risk management and providing a framework for climate-related financial risk management. According to the OCC, “[w]eaknesses in how banks identify, measure, monitor and control the potential physical and transition risks associated with a changing climate could adversely affect banks’ safety and soundness.”  

The Federal Deposit Insurance Corp. stated, in a February 2022 press release, that financial risks posed by climate change are a priority. Efforts will include seeking public comment; establishing an interdivisional, interdisciplinary working group; and coordinating with international counterparts.  

While the OCC and the FDIC have put forth a more unified supervisory message, the Federal Reserve has been less clear on the immediate impacts on financial stability. Chair Jerome Powell’s January 2022 Senate confirmation hearing reaffirmed in the eyes of many a reluctance to make climate change a top priority. Chair Powell’s track record does include a commitment to study climate change’s impact on financial institutions and the creation of internal committees to explore the issue. However, his responses during his confirmation hearing indicate that the Federal Reserve’s regulatory role in climate change is “a narrow one” related to the Federal Reserve’s existing mandate to ensure that institutions regulated by it understand and manage their risks.

Armand J. Santaniello

Could Stress Tests Be a Solution? 

Chair Powell’s stance on climate change is likely to be counterbalanced by those of current Fed Governor Lael Brainard, President Joe Biden’s choice for vice chair of the Federal Reserve board of governors. Brainard is on the record as acknowledging the negative impact of climate change on the financial system.  

One proposed approach would be to integrate climate change into existing bank stress tests. Stress tests were implemented as part of the response to the 2008 financial crisis and assess whether banks maintain enough capital to withstand negative economic events. Traditionally, these events would include economic downturns, but could incorporate negative climate events. Another proposed approach, discussed by Governor Brainard in the fall of 2021, would be to conduct climate scenario analyses to understand the risks posed to financial institutions by climate change, without having an impact on capital requirements.  

Notably, however, Governor Brainard did not affirmatively endorse climate stress tests during her confirmation hearing. Bloom Raskin, a former Governor of the Federal Reserve during the Obama Administration and President Biden’s choice for Vice Chairman of Supervision, withdrew her name from consideration on March 15 in large part because of intense political pressure stemming from her belief that bank regulators should play a larger role in addressing the threat that climate change could pose to the financial system.  

Other Nations Already Stress-Test 

The concept of factoring the risks associated with climate change into financial stability assessments in other countries goes back to 2019, when the governors of the Bank of England and the Bank of France penned an open letter and called upon policymakers and the financial industry to “integrate the monitoring of climate-related financial risks into day-to-day supervisory work, financial stability monitoring and board risk management.” The Bank of France and the Bank of England have already conducted climate stress tests, and it is anticipated that the European Central Bank will do so in the near future. 

International financial regulators have taken additional steps aside from conducting climate stress tests. The Bank of Japan recently offered billions in zero-interest loans to financial institutions to promote activities to curb climate change by providing “green” lending to consumers. The central banks of China, India, South Korea and New Zealand have relatedly increased the purchase of “green” bonds. Additionally, the Swedish Central Bank and Bank of France have begun to deemphasize business and investments in natural resources such as coal, oil and gas.  

The importance of climate change as a factor in assessing financial stability has gained ground in recent years, but the speed at which U.S. regulators adopt approaches taken internationally remains to be seen. With the Biden administration’s emphasis on the issue, we can expect developments in line with those seen across the world notwithstanding strong political opposition.  

Thomas J. Curry is a partner in Nutter’s corporate and transactions department. Kate Henry and Armand J. Santaniello are associates in Nutter’s corporate and transactions department. Curry is former U.S. comptroller of the currency and all are members of the firm’s banking and financial services group. 

Regulators Heighten Focus on Climate Change’s Financial Risks

by Banker & Tradesman time to read: 4 min