There is no doubt that climate-related risk regulations are coming down the pike. Every federal regulator, including all the bank regulators and the Securities and Exchange Commission, have expressed their concerns about climate risk and the need to develop regulations to assess climate-related risk for banks and publicly held companies. However, there are a number of serious obstacles to developing appropriate regulations. These include political impediments, the complexity of climate-related risk and the development of a framework to measure climate-related risk.
As someone who has devoted 28 years to bank regulatory compliance, specifically the Community Reinvestment Act, and as a former Connecticut state senator I can appreciate the regulatory obstacles and the political hurdles that impede progress on this controversial and complex issue. Based on my political and regulatory experience I suggest the following ideas to move forward.
First, recognize the complex and controversial nature of climate-related risk and initiate the development of regulations as a series of steps, rather than trying to pass a “perfect” and all-encompassing set of regulations immediately.
Don’t Let Perfect Stop Good
Climate-related risk can be broken down into three general areas; (1) the measurement of risk as it exists today, (2) the measurement of risk and the consequences of climate change in the future and (3) government policies in response to perceived climate-related risk. Of these areas, the least controversial is the measurement of climate-related risk as it exists today.
My political experience as a state senator has taught me that a consensus to pass major legislation is difficult and develops incrementally. The most successful approach begins with the least controversial elements of a public policy issue and builds a consensus approach gradually. Advocates for climate-related risk regulations should not let the “perfect be the enemy of the good.”
What does this mean? First, propose legislation and regulations based on climate-related risk as it exists today, without the speculation of what it may be in the long-term future. While climate-related risk 50 to 75 years from now is a relevant concern, it is fraught with speculation and far exceeds the time horizon for a bank’s strategic planning. The science itself is filled with complexity as reflected in the CMIP project in which about 50 scientific groups sanctioned by the IPCC have developed approximately 100 different global warming models predicting a wide range of outcomes between now and 2100.
A big obstacle to climate-related risk regulations is that a transparent quantifiable framework has not been recognized by the three main bank regulators. On Dec. 16, 2021, the Office of the Comptroller of the Currency issued a request for comment on the agency’s document, “Principles for Climate-Related Risk Management for Large Banks” and on Sept. 29, 2022, the Federal Reserve Board announced six of the nation’s largest banks will participate in a pilot climate scenario analysis exercise designed to “enhance the ability of supervisors and firms to measure and manage climate-related financial risks.”
The prudential bank regulatory agencies have now embarked on research to identify what climate-related data is currently available. In fact, some commenters in response to the OCC’s request for comments spoke about “data gaps” that “frustrate attempts to accurately identify climate-related financial risks.”
Data Is Already Available
Ironically in-depth, quantitative and transparent data is already available, but regulators appear unaware of the voluminous data regarding natural hazards (ranging from droughts, to hurricanes, to cold waves and heat waves, etc.,) developed by the Federal Emergency Management Administration (FEMA). Moreover, the structure of the FEMA data is compatible with existing federal bank regulations as they pertain to the Community Reinvestment Act and fair lending rules because it has also been compiled on a census tract level.
It’s an ideal opportunity to weave climate risk data and analysis into the existing regulatory framework. In fact, several New England banks have applied the data to develop “climate-related risk profiles” for their institutions with great success.
Exactly as is done for CRA and fair lending analysis, a picture of a bank’s exposure can be created right now on a census tract basis that allows for mapping and spatial analysis of climate-related phenomena in a bank’s assessment areas, REMA’s, etc. With that data, pictures of the climate-related risks that currently exist in any bank’s markets can be developed and risk exposure and ratings applied to bank facilities, loan portfolios, and any other records with a geographic component. Community climate-related risk profiles can be determined as well as a bank’s exposure to any balance sheet line item down to the most granular analysis.
Before climate-related risk forecasts can be developed, banks need to know their starting point: What is their current climate-related risk exposure? That data is now available and is the necessary starting point for future climate-related risk regulations.
Len Suzio is president of bank compliance consultancy GeoDataVision LLC.