A senior Federal Reserve official issued a sharp warning Thursday morning that banks and other lenders must prepare for the realities of a climate-changing world, and regulators must play a key role in ensuring this.
“Climate change is already causing significant economic costs and is expected to have profound effects on the domestic and international economies,” said Lael Brainard, one of the six governors of the Washington Central Bank, at an event hosted by the Institute of International Finance.
“Financial institutions that fail to create a framework to measure, monitor and manage climate-related risks could suffer excessive losses in climate-sensitive assets from environmental shifts, a disorderly transition to a low-carbon economy, or a combination of both,” she continued.
The grim backdrop for their comments is the unusually cold weather in Texas, which leaves millions of people without electricity and underscores the fact that state and local authorities in some locations are unprepared for severe weather, which is expected to occur more frequently.
Such disruptions are also important to the financial system. They pose risks to insurers, can disrupt the payment system and call into question otherwise sound financial betting. Therefore, it is important for the Fed to understand and plan for it, central bank officials have increasingly said.
Ms. Brainard pointed out on Thursday that financial companies are countering the risk by, among other things, “responding to investors’ demands for climate-friendly portfolios”. But she added that regulators like the Fed also have to adapt. She pointed out the possibility that bank regulators may need new supervisory tools given the challenges associated with climate surveillance, which include long time horizons and limited data due to the lack of precedents.
“Scenario analysis can be a useful tool to” assess the impact of climate-related risks under a variety of assumptions, “said Ms. Brainard, although she was careful to ensure that such scenarios would differ from full-fledged stress tests.
The public assessment of climate risks is uncharted territory for the Fed. Officials tiptoed around the issue, which is politically indicted in the United States, for years. The central bank only joined a global coalition at the end of last year dedicated to research into protecting the financial system against climate risks. The possibility of climate-related stress testing has been particularly controversial and has recently been criticized by Republican lawmakers.
“We have seen banks make politically motivated and public relations decisions to limit credit availability to these industries,” said more than 40 Republican lawmakers in a December letter referring specifically to coal, oil and gas . They added that “climate change stress tests could continue this trend and allow regulated banks to use negative impacts on their regulatory testing as an excuse for defusing or divesting these crucial industries.”
In response, Jerome H. Powell, chairman of the Fed, and Randal K. Quarles, vice chairman of oversight – both named for their work by President Donald J. Trump – suggested that the Fed should be at an early stage of research into their Role in climate supervision.
“We would like to point out that it has long been the policy of the Federal Reserve not to dictate to banks which legitimate industries they can and cannot serve, as these business decisions should be made solely by each institution,” they wrote last month.
Mr Powell and Mr Quarles reiterated the legislature’s claim that the Fed’s bank stress tests measured banks’ capital needs over a much shorter period than climate change, despite saying the Fed was working to help banks manage their risks, including the associated climate.
The central bank is rapidly moving towards more activism in this area. The Monitoring Climate Committee, announced last month, will “work to develop an appropriate program” to monitor banks’ climate-related risks, Ms. Brainard said Thursday. The Fed also co-chairs a task force on climate-related financial risks in the Basel Committee on Banking Supervision, a global regulatory group.
Although the central bank is politically independent, President Biden has placed climate at the center of his administration’s economic priorities. Treasury Secretary Janet L. Yellen has pledged to “fight the climate crisis”.
Ms. Brainard, the last remaining Fed governor appointed solely by President Barack Obama, was a leading voice in calling for greater awareness of climate issues and spoke at a conference on the issue in 2019. Also Mary C. Daly, President of the Federal Reserve Bank of San Francisco, who hosted the conference. (Mr. Powell was originally appointed by Mr. Obama, but then named chairman under Mr. Trump.)
“It is a fact that severe weather events are on the rise,” Ms. Daly said during a webcast event this week, noting that “half the country is in a winter storm and then they will be in a heatwave in summer.” ”
She said the Fed needs to figure out how to deal with potentially disruptive risks as it is responsible for the country’s economic health, works with other regulators to protect the security of the financial system, and is the administrator of the payments system. the bowels of the financial system, where money is sent and checks are processed.
“We need to understand what the risks are and think about how these risks can be mitigated,” said Ms. Daly. “Our responsibility is to look ahead and not only ask what is happening today, but also what the risks are.”