Chairman Barr, Ranking Member Foster, and members of the subcommittee thank you for the opportunity to discuss the Federal Reserve’s oversight work related to financial risks related to climate change.
The Federal Reserve’s responsibilities for climate change are significant, but limited. These responsibilities are closely linked to our responsibilities for banking supervision and financial stability. Given that climate change could pose challenges to the financial system, it is important that we better understand these risks. Our main objective is to assess whether banks operate in a safe and sound manner and manage all material risks, including climate-related financial risks. We also work rigorously to identify and measure how climate change could increase financial sector vulnerabilities and amplify shocks.
My remarks today will focus on the oversight work of the Federal Reserve. Before proceeding, it is important to highlight two general points about our approach. First, the Federal Reserve recognizes that decisions about policies to address climate change should be made by the elected branches of government. As President Powell said earlier this year, the Federal Reserve is not a climate policymaker.1 The Federal Reserve’s oversight responsibilities focus on understanding and mitigating the potential impact of climate change on supervised banks.
Second, it has never been Federal Reserve policy to discourage banks from offering accounts or services to any class or type of law-abiding business, and that is not part of our review work. climate-related financial risks.
Overview of monitoring
Our oversight work related to financial risks related to climate change builds on our core responsibility to ensure that banks understand and appropriately manage all material risks, including those related to climate change. Weaknesses in how banks identify, measure, monitor and control climate-related financial risks could undermine their safety and soundness. To fulfill this oversight responsibility, the Federal Reserve is working to better understand the potential implications of climate change for supervised banks, working with major banks, conducting independent analysis of potential risks and opportunities, discussing issues with a wide range of external experts and monitoring. industry developments.
Banks are likely to be affected by both physical and transition risks associated with climate change, collectively referred to as climate-related financial risks. Physical hazards refer to damage to people and property resulting from acute climatic events, such as hurricanes, wildfires and floods, as well as chronic climatic changes, including higher average temperatures, changes in rainfall patterns and sea level rise. Transition risks refer to strains on institutions or sectors resulting from shifts in consumer and business sentiment, technologies or policies associated with changes that would be part of of a transition to a lower carbon economy.
These risk factors can manifest as traditional banking risks, including credit, market, liquidity, operational and legal risks that are central to a bank’s traditional risk management framework. Although there is considerable uncertainty about the timing and magnitude of the impact of climate change in different institutions with different risk profiles, it is prudent to build capacity to better understand the range of risks. Big banks, for example, are increasingly focusing on the risks and opportunities that climate change brings, and supervisors need to be aware of this.
The Federal Reserve has two near-term oversight priorities related to financial risks related to climate change: issuing interagency guidance for large banks and conducting a pilot climate scenario analysis exercise. Both of these will deepen our understanding of climate-related financial risks and support the resilience of supervised companies.
I will briefly discuss each of these efforts.
Advice
Last December, the Federal Reserve invited public comment on draft guidelines providing a high-level framework for the safe and sound management of climate-related financial risk exposures for large banks.2 The principles-based guidance would apply only to banks with total consolidated assets over $100 billion. These Proposed Principles are substantially similar to the Proposed Principles issued by the Office of the Comptroller of the Currency (OCC) in December 2021 and by the Federal Deposit Insurance Corporation (FDIC) in March 2022.
The proposed guidance contains high-level principles covering six areas: governance; policies, procedures and limits; strategic planning; risk management; data, risk measurement and reporting; and scenario analysis. The guidance also outlines how climate-related financial risks can be addressed in specific prudential risk areas, including credit, liquidity, other financial risks, operational, legal and compliance risks, and other risks. non-financial.
The Federal Reserve has received a large number of comments and its services are carefully reviewing all comments received. We intend to coordinate with the OCC and FDIC to issue any final guidance to promote consistency in the supervision of large financial institutions.
Scenario analysis
Climate scenario analysis – in which the resilience of financial institutions is examined under different climate scenarios – is an emerging risk management and monitoring tool used to assess climate-related financial risks.
The Climate Scenario Analysis (CSA) pilot exercise was launched in January with six of the largest banks. This exercise was designed with two objectives: to learn about the practices and challenges of large banking organizations in terms of climate risk management and to improve the capacity of large banking organizations and supervisors to identify, measure, monitor and manage financial risks related to climate change. climate.3 The exercise should be completed by the end of the year.
The six participating banks will analyze the impact of physical and transition risk scenarios related to climate change on specific assets in their portfolios. We will gather qualitative and quantitative information during the pilot, including details on governance and risk management practices, measurement methodologies, risk metrics, data challenges and lessons learned.
The Federal Reserve plans to release information from the pilot project, reflecting what we are learning about climate risk management practices and how information from scenario analysis will help identify potential risks and promote effective climate risk management practices. risk management. No company-specific information will be disclosed.
I should stress that we view climate scenario analyzes as distinct and separate from the Federal Reserve’s prudential stress test. The Federal Reserve’s stress test is designed to assess whether large banking institutions have enough capital to continue lending to households and businesses during a severe recession and financial market shock. The CSA pilot exercise, on the other hand, is exploratory in nature and has no implications for bank capital or supervisory implications.
Conclusion
As I mentioned at the beginning of my testimony, the Federal Reserve’s role in climate change is important, but limited. The Federal Reserve has a duty to understand the risks to the safety and soundness of the banks it oversees and to the financial system, including financial risks related to climate change.
THANKS. your questions are welcome.
1. President Jerome H. Powell, Panel on “Central bank independence and mandate: changing views”, speech given at the Symposium on Central Bank Independence, Sveriges Riksbank, Stockholm, Sweden, 10 January 2023. Back to text
2. Federal Reserve Board of Governors, “The Federal Reserve invites public comment on proposed principles providing a high-level framework for the safe and sound management of climate-related financial risk exposures for large banking organizations,” press release, December 2, 2022. Back to text
3. Federal Reserve Board of Governors, Climate Scenario Analysis (CSA) pilot exercise: instructions to participants (Washington: Board of Governors, January 2023). Back to text
