WASHINGTON — Several financial regulators were already moving in the direction of incorporating climate change risk in their monitoring of banks and financial institutions. On Thursday, they got validation from the highest level of government.
President Biden's sweeping order directing member agencies of the Financial Stability Oversight Council to examine financial risks posed by climate change could lead to concrete changes in bank stress tests, mortgage underwriting rules and flood insurance pricing, observers said.
Broadly speaking, the move brings new urgency to steps regulators have already explored or considered, some said, while providing agencies with more cover to craft regulatory policies that Republicans have attacked as politically motivated. The executive order requires the FSOC to issue a report on policy recommendations in 180 days.
“In some ways, it is going to be a modern day war chest, in that Democrats are going to look at the executive order and say, ‘This is exactly what we need to do to ensure the safety and soundness of these institutions and of our economy, and there is a direct connection between the environment and the economy,’ ” said Ed Mills, a policy analyst with Raymond James.
The administration's missive on climate-related financial risks outlines a “whole of government” approach to safeguarding financial stability.
“This executive order I think does have the appropriate urgency, and we appreciate that the president did it in his first 150 days, and [that] each of those areas have a timeline,” said Steve Rothstein, managing director at the Ceres Accelerator for Sustainable Capital Markets. “It is an urgency that we hope every bank feels.”
Biden’s
The order also instructs Biden’s national climate advisor, Gina McCarthy, and Brian Deese, the director of the National Economic Council, to develop within 120 days a “comprehensive government-wide climate-risk strategy” to pinpoint and disclose climate-related risks to government programs, assets and liabilities.
“With so much at stake, this Executive Order ensures that the right rules are in place to properly analyze and mitigate these risks,” a fact sheet outlining the directive reads. “That includes disclosing these risks to the public, and empowering the American people to make informed financial decisions.”
Under the order, the Department of Housing and Urban Development Secretary Marcia Fudge, along with the heads of the Agriculture Department and the Department of Veterans Affairs, will also be required to consider incorporating climate risk into underwriting standards for government-backed mortgages.
Analysts say regulators could spotlight the risks of lending to homeowners or builders for properties more susceptible to flooding.
“This should change mortgage underwriting. That means consumers seeking to buy homes that are more at risk of flood damage or to other impacts from climate changes may have more trouble getting credit or may need to pay more for their mortgages,” said Jaret Seiberg, an analyst at Cowen Washington Research Group, in a research note.
Rothstein said policymakers should consider subsidies for homeowners who cannot afford flood insurance protection.
"We should build the real price of the cost of a mortgage, including flood risk, into that mortgage price, and if people can’t afford it, we should build in those subsidies, and we should figure out how to address that or else we will be institutionalizing segregation and the racism that exists for another generation,” he said.
The executive order comes as numerous regulators including the Federal Reserve,
But it still matters for the White House to lay out the same set of goals for protecting financial stability.
“The whole financial industry is so incredibly complex and interwoven, and so it makes sense that from the top, that we begin really with a collective effort to go assess and identify the risks that are out there, so that each component of this very intricate machine can then address the risks that are seen,” said Randell Leach, CEO of Beneficial State Bank, a community development financial institution with more than $1 billion of assets.
The SEC has sought input on developing new disclosures about climate change risk for public companies, including banks. Biden’s executive order also provides support for the Fed to continue exploring the idea of stress testing banks against climate risk.
“This endorses the idea that financial firms should be stress tested on their exposure to climate change," said Seiberg. "This means assessing whether financial firms are especially exposed to areas that could be subject to floods, hurricanes, and fires. And if losses from any of these climate change events could threaten solvency of financial firms, which could then put the financial system at risk. As a result, we see climate change stress testing as part of the new normal.”
Jamal Raad, the executive director of Evergreen Action, called the executive order “groundbreaking.”
“For the first time ever, an American president is taking bold action to address the risks that climate change poses to our financial system, our lives and our livelihoods,” he said in a statement.
The existing work from bank regulators to examine climate risk, along with Thursday’s executive order, has come under fire from Capitol Hill Republicans who argue that global warming is outside the scope of the banking agencies.
“Today’s executive order demonstrates that the Biden administration is preparing to misuse financial regulation to further environmental policy objectives,” Sen. Pat Toomey of Pennsylvania, the ranking member of the Senate Banking Committee, said in a statement after the directive was issued.
Rep. Frank Lucas, R-Okla., said in a statement that the directive was an “overstep of the executive branch and the agencies who serve our nation’s financial system.”
“Instead of financial regulators who lack the know-how or an administration who vows to put their thumb on the scale of businesses and industries serving the American people, it should be Congress and innovation that moves our country towards a cleaner future,” he said.
For Republicans like Toomey and Lucas, the effort to incorporate climate risks into bank regulation is likely reminiscent of Operation Choke Point, an Obama-era program that sought to investigate banks doing business with “higher risk” companies, like gun dealers and payday lenders, said Mills.
“There is a desire for both Democrats and Republicans to say, this is why it matters who you vote for president, because these regulatory agencies have the ability to impact all of these different parts of the executive branch and how our government prioritizes different policies,” he said.
But despite the executive order, regulators are likely to continue moving carefully on climate change until they get their arms around current climate models and how they can measure bank exposure, said Cliff Rossi, executive-in-residence and professor at the University of Maryland’s Robert H. Smith School of Business.
“You can make some terrible economic decisions based on this,” said Rossi, a former senior risk executive at Citigroup who is studying the effects of climate change on housing. “We have to understand what’s going on first with the climate models we use before making assessments.”
Biden’s executive order could help to offer more visibility in that space, said Leach.
“The risk is real and what we don't have is good information on how to manage it, especially in the banking sector,” he said.
The order could also be a wake-up call for banks that were not yet paying attention to their exposure to assets that could be affected by climate change, said Rothstein.
“This order will indirectly affect every bank, not directly from a regulatory perspective, but it will have an impact, and the message is: Climate is a real risk,” he said. “It's also a real opportunity from a business perspective — new businesses, new jobs — and that everyone needs to play a role to address this.”
