Three years after other major central banks began to focus on the risks to their financial systems from climate change, the Federal Reserve has started the process of catch-up.
“Addressing climate-related risks and opportunities… will not be easy,” Federal Reserve Governor Lael Brainard said Thursday.
“The long time horizon associated with climate change, the lack of historical data, the potential for sudden shifts in asset valuations, and the paucity of information on the climate-sensitivity of exposures complicate the translation of climate-related risks into measures of credit, market, liquidity, reputational, and operational risks,” Brainard said.
In her remarks Brainard suggested she favors “mandatory disclosures” to help investors assess and price climate risks. Brainard stressed she was not speaking for the entire Fed board of governors.
She said that “scenario analysis” might be a tool to assess risks to banks under a wide range of assumptions rather than including climate change in the Fed’s annual bank stress tests.
While some observers said that is good news for banks, former Fed Gov. Daniel Tarullo said the Fed’s stress-test process was not the appropriate vehicle to measure climate change.
“When people talk about stress testing on climate change, it has got to be something different from what we think of the Fed’s annual stress test… because the stress test is a scenario that plays out over the next nine quarters, and obviously that is unlikely to be the critical period for the impact of climate change,” Tarullo said as part of a recent Banking With Interest podcast.
Mostly Republican lawmakers have also pushed back on the Fed’s earlier indications it is mulling stepping up climate-related regulation of banks.
The Bank of England is close to launching a climate stress test and the Fed can learn from their experience, Tarullo said.
“The Fed is definitely playing catch up here,” said Gregg Gelzinis, associate director for economic policy at American Progress.
“I feel like the Fed is in the ‘evaluate, analyze and sharpen their understanding’ phase of this risk, and then, I think, the next natural step is obviously, to take action and actually integrate this focus into their regulation and supervision of financial institution,” he said.
Exactly what’s on the Fed’s plate?
“The problem that is trying to be solved is to mitigate the risks that climate change poses to the stability of the financial system and to the safety and soundness of individual financial institutions,” Gelzinis said.
Climate change could cause catastrophic losses in the financial system.
The Commodity Futures Trading Commission led a bipartisan group late last year that released a first-of-its-kind climate-change report for the financial sector. The report labeled climate change as the biggest long-running risk to the financial system and recommended that 16 financial regulators and other bodies “incorporate climate-related risk into their mandates and develop a strategy for integrating these risks in their work, including into their existing monitoring and oversight functions.”
Central banks and supervisors from other countries joined together in late 2017 to share best practices and develop climate risks assessments.
A key message of Brainard’s speech was the Fed will try to improve its understanding of climate risk while at the same time taking steps to mitigate the risks.
The Fed “has to work on parallel tracks here,” Gelzinis said.
The U.S. has a fragmented system for overseeing the financial markets and the top regulatory agencies, including the Securities and Exchange Commission and the Treasury Department are adding climate czars to their staffs.
A separate banking regulator, the Office of the Comptroller of the Currency has paused under the new administration a Trump-era rule change that would have required banks to provide quantitative measurements to back decisions to not lend to oil and gas industries where there are both financial stresses and reputational risks.
Disjointed rules and goals has been a major gripe from an investing and lending community that’s increasingly factoring in climate change to decision-making.
Gelzinis said he hoped the government’s umbrella regulatory body — the Financial Stability Oversight Council — would supervise the response to climate financial risks.
“Climate change really is the type of risk that FSOC was designed to address, one that’s cross-cutting and impacts a whole host of different regulators,” he said.
He said the Treasury climate-change point-person will also have to tackle tax policy and international cooperation.