WASHINGTON — A long-anticipated federal report on climate change’s risk to the U.S. economy is not the regulatory nightmare that some bankers had feared, but the recommendations could shape decades of financial policy.
The Financial Stability Oversight Council, led by Treasury Secretary Janet Yellen and consisting of U.S. financial regulators, released a
Among the recommendations, FSOC’s report stressed the need for markets and regulators to have “better data and information, including enhanced and transparent disclosures” to gauge the dangers of climate change.
It also promoted climate-focused scenario analysis, which the Federal Reserve
Still, while the report marks one of the most significant policy developments in response to climate change from financial regulators, many climate activists were disappointed that FSOC stayed clear of more ambitious policy recommendations.
The FSOC report “provides a strong analysis of the significant threat that climate change poses to financial stability,” said Alex Martin, a senior policy analyst for Americans for Financial Reform. “Unfortunately, it largely avoids laying out specific policy recommendations for U.S. regulators to catch up and surpass our international peers in mitigating climate risk — an urgent task needed to protect the financial system.”
Even in the absence of stronger recommendations, however, the report signaled that more significant policies are on their way.
What follows are key takeaways from the report, and what bankers can expect from climate-related policy in the coming months.
Disclosures, disclosures, disclosures
A clear focus from the FSOC report, released Thursday, is for regulators to be able to grasp the full scope of risk that climate change poses to the financial system. To that end, one of the most concrete recommendations from the report calls on government agencies to expand and enhance the data they collect from financial institutions.
FSOC members should develop disclosures for firms "to help determine exposure to material climate-related financial risks,” according to a fact sheet released by the regulatory body. The council also urged agencies to standardize their disclosures among peers “to promote comparability.”
Developing more robust climate disclosures of some kind has been a key objective for many investors, risk analysts, climate activists and, most recently, the Biden administration.
The Securities and Exchange Commission, led by Chair Gary Gensler, has undertaken the best-known effort to develop a disclosure regime for climate risk.
Analysts say it appears likely that bank regulators will try to follow the SEC’s lead in some fashion, potentially bringing climate disclosure requirements to a wider swath of depository institutions.
The FSOC report could “lead to the banking agencies requiring banks to collect more data for internal use from corporate clients on their climate change risks,” said Jaret Seiberg, a financial policy analyst at Cowen Washington Research Group. “Such data would better allow banks to evaluate their exposure to different climate change risks.”
U.S. regulators will coordinate climate risk policies with global peers
FSOC’s report also makes clear that when it comes to climate change, U.S. regulators are not an island. They will be expected to work with counterparts in other countries to combat the risk of climate change on the financial system.
“Given the interconnectedness of the global financial system, it will be critical to ensure that FSOC members work with their international counterparts both bilaterally and through relevant international bodies to address collective challenges,” the council said in its fact sheet.
FSOC urged U.S. regulators to work with global counterparts to identify climate data gaps and develop key metrics that can be part of an international response.
The council recommended that U.S. regulators collaborate with the Financial Stability Board, Basel Committee on Banking Supervision, International Organization of Securities Commissioners, International Association of Insurance Supervisors, Sustainable Insurance Forum and the Network of Central Banks and Supervisors for Greening the Financial System.
The Federal Reserve Board announced in December that it would join the Network for Greening the Financial System, and the central bank was followed by the Office of the Comptroller of the Currency in July.
The last of the prudential bank regulators — the Federal Deposit Insurance Corp. — has yet to commit to NGFS membership and likely won’t under Chair Jelena McWilliams, a Trump appointee and FSOC member who abstained from approving Thursday’s report.
No limits on fossil fuel lending in sight
The FSOC report did not recommend any hard limits on banks’ lending to fossil fuel companies, disappointing critics who were hoping for an aggressive crackdown.
David Arkush, director of the climate program at Public Citizen, lauded regulators for sending a “strong signal to Wall Street that U.S. financial regulators are getting serious about climate risk.” But he also said FSOC only laid out “bare-minimum first steps” and called on regulators to rapidly shift gears.
Environmental groups agreed that omitting lending curbs was a missed opportunity.
“By leaving out key risk-reduction tools, it is not treating the problem with the urgency it deserves,” Ben Cushing, manager of the Sierra Club Fossil-Free Finance Campaign, said in a press release.
Many U.S. banks have cut back on their lending to the fossil fuel industry, but the four largest banks still financed some nearly $170 billion worth of loans in 2020, according to a report from the Rainforest Action Network and other groups.
A handful of regional and midsize banks also focus more heavily on energy lending, such as BOK Financial in Oklahoma and Cullen/Frost Bankers and Cadence Bancorp, both of Texas.
In a research note the day before the FSOC report was released, Seiberg said strict limits on banks’ lending would be a “politically contentious step for a risk-adverse FSOC to take” and that bigger changes may require Congress’s involvement.
Climate risk capital charges are off the table — for now
In a win for the industry, the FSOC did not recommend implementing formal climate stress tests, which could examine banks’ resilience to climate risks and in turn affect their capital requirements.
The report did acknowledge early efforts in other countries to weigh the feasibility of climate stress tests, citing the Bank of England, European Central Bank and Singapore’s central bank.
But the FSOC noted those preliminary steps “have not yet been used to impose direct supervisory or regulatory consequences,” unlike the regular stress tests that regulators across the world began imposing after the 2007-09 financial crisis.
The liberal-leaning Center for American Progress has suggested that the Fed add climate-related risks into its current stress tests, which gauge banks’ capital adequacy. It also has floated longer-term climate stress tests as an option, saying regulators should take a “qualitative” approach to gauging banks’ transition plans due to the massive uncertainty of long-term quantitative climate analyses.
The Bank Policy Institute, which represents bigger banks, has pushed back against climate stress tests. BPI has noted those exams would rely on scientific climate projections that are not perfect, that the data on borrowers’ climate risks is sparse and that adequately accounting for climate change’s effects on banks is “daunting.”
FSOC instead recommended that regulators use “scenario analysis” tools, which would gauge how banks would fare under different possible outcomes but are not as punitive as stress tests. “Given current knowledge and tools, exploratory scenario analysis provides a framework for assessing climate-related financial risks and next steps for regulators,” the FSOC wrote.
Those analyses could measure companies’ resilience to major weather events, more “chronic” physical risks like sea-level rises and “transition risks” such as how banks’ loan books might perform if fossil fuel prices decline rapidly, the report said.
Regulators could look at medium-term risks over the next 10 years as well as longer-term risks that may take decades to unfold, the report added.
In a press release, BPI said it welcomed the FSOC’s recommendations.
“The development of risk management tools, such as scenario analysis, that integrate traditional financial variables with plausible climate scenarios and emission reduction pathways will be crucial to ensuring risks are measured and managed appropriately,” said Lauren Anderson, senior vice president at the Bank Policy Institute.
Those tools “serve the purpose of risk identification and strategic decision making as opposed to assessing capital adequacy,” she added.
