California's wildfires could spark a dangerous new banking crisis

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For years, Californians have feared "The Big One," a massive earthquake that could wreak havoc on the state. However, the devastation across Southern California in recent weeks suggests that wildfires are an even bigger threat and a more material risk to local communities, banks and society. The fires ravaging the state have destroyed thousands of homes and caused an estimated $250 to $275 billion in damages — more than 6% of the state's GDP. These fires are just the latest example of climate disasters placing immense financial strain on individuals, businesses and the broader banking system.

The damage from these fires is not just a problem for homeowners; it's a ticking time bomb for banks and the broader economy. In recent years, the mass exodus of private insurers has left families increasingly vulnerable, forcing many to rely on high-cost, limited-coverage public insurance programs. However, even those who still have private insurance may find the coverage to be inadequate for rebuilding after a disaster. And, for families with total losses, the decision of whether to abandon their homes and default on mortgage payments is all too real. This all leads to a cascading financial impact: Banks are left holding the bag, and taxpayers will ultimately bear the cost of government-backed mortgage loans in default.

The situation is also very serious for banks — megabanks that operate throughout the nation as well as smaller, community-based banks that operate exclusively in California. In particular, smaller banks, many of which serve low-income and minority customers, face direct exposure to the communities that are now reeling from the devastating effects of climate-driven disasters. The latest data shows that 98 banks operate exclusively in California, and nearly a quarter of those are concentrated in Los Angeles County, where wildfires have caused the most destruction. Unlike megabanks, which can rely on diversification to weather a crisis, these banks are particularly vulnerable because of their geographic concentration. If homeowners are forced to walk away from their homes due to insufficient insurance coverage, financial losses will trickle down to these community banks and the neighborhoods they serve.

This growing crisis is not isolated to California. It's part of a broader pattern of escalating climate risks that threaten the stability of the entire financial system. A recent Senate Budget Committee report highlighted how climate change could wipe out up to 9% of the world's housing value by 2050, amounting to a staggering $25 trillion in lost wealth. When property values decline, the wealth of homeowners — who rely on their homes as their primary source of financial security — erodes. This could lead to a housing market crash rivaling the 2008 financial crisis. Unlike the 2008 crash though, the homes and communities that are damaged by climate disasters may never recover their value.

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The financial risks are further compounded by regulators' failure to adequately address climate-related financial risk. Despite mounting evidence of the vulnerability of both homeowners and banks to climate risks, federal banking regulators have been slow to act. For example, Travis Hill, the acting chairman of the Federal Deposit Insurance Corp. Acting FDIC Chairman Travis Hill recently dismissed the threat of climate-related financial risk, claiming that banks actually benefit in the aftermath of disasters because loan demand grows and recovery funds flow into the community. This view is dangerously shortsighted and fails to account for the long-term, systemic risks that climate-related financial risk presents, both to individual banks and the financial system as a whole.

In light of these mounting risks, regulators must take immediate action to protect the financial system and the millions of Americans who are vulnerable to climate disasters. First and foremost, banking regulators must require large banks to regularly assess and disclose climate-related financial risks as they do for other risks. This means identifying climate-related vulnerabilities in their portfolios and taking concrete steps to mitigate those risks. Banking regulators must also work with climate scientists to develop appropriate models for assessing climate risks, and they must ensure that banks use these models to guide their decision-making. Finally, the federal government must acknowledge the indirect economic impacts of climate change, such as job losses and disruptions to local economies, and take steps to support communities in the aftermath of disasters.

The time to act is now. Each day that passes without addressing the growing threat of climate-related financial risk puts us closer to a banking crisis that could damage the entire economy and financial system.