Wall Street sees the Fed’s first climate change review in 2023

Climate activists oppose US President Joe Biden’s reappointment of Jerome Powell for a second four-year term as chairman of the Federal Reserve and demand that Biden appoint a climate attorney during a rally outside the Federal Reserve in Washington, USA, on October 29, 2021. REUTERS / Leah Millis

WASHINGTON, Nov. 17 (Reuters) – As the US Federal Reserve lags behind other major central banks in fighting climate change, it is catching up on one critical front: figuring out whether rising temperatures could topple a major bank or even the entire financial system.

The potential impact of climate change – namely, rising sea levels, worsening floods and fires, and the government moving away from carbon-intensive industries – could destroy trillions in assets around the world. As major lenders to the oil and gas industry, US banks could be in the eye of the storm, according to regulators and risk management experts.

A report led by the Treasury Department last month warned that rising temperatures were a “new threat” to financial stability and regulators should use scenario analysis to develop robust tools for predictive risk management.

Although the Fed is the most influential central bank in the world, it lags long behind its competitors in getting these risks under control.

Last year, however, the Fed increased pressure on big banks to screen their portfolios for climate change risks and, according to seven industrial companies, it may be able to conduct a formal scenario analysis and publish comprehensive results in 2023 by executives with direct knowledge of the Discussions that refused to be mentioned.

The previously unreported growing industry consensus shows how regulators are trying to quickly implement President Joe Biden’s agenda to incorporate climate risk into the financial oversight system, with a significant impact on Wall Street banks like JPMorgan Chase & Co (JPM.N) Citigroup (CN .). ), Wells Fargo & Co (WFC.N), Bank of America Corp (BAC.N), Goldman Sachs Group (GS.N) and Morgan Stanley (MS.N).

A formal analysis of the climate change scenario would give regulators and investors the clearest picture yet of the threats posed to big banks by climate change and increase pressure on the industry to deliver on commitments made at the UN climate summit earlier this month to move away from fossil fuel lending .

“Right now there is really no data on the scope and magnitude or truly system-wide risk,” said Todd Phillips, director of the think tank Center for American Progress.

The banks declined the request for comment or did not respond.

Some European regulators have already started testing their banks for climate change risks.

Reuters reported in May that Fed regulators had begun privately pushing lenders for data and details about their efforts to assess their loan books’ exposure to climate change.

These discussions are being driven by Kevin Stiroh, who began leading the Fed’s climate oversight work in February. It has intensified over the past few months and, according to executives, has started to focus on how a balance sheet scenario analysis might work.

“By and large, regulators are moving at full speed in this regard,” said Sean Campbell, director of policy research at the Financial Services Forum, which represents large banks, adding that a 2023 timetable is “about right”.

Fed officials have not previously indicated when they would expect an analysis to be conducted. In an interview with Reuters, Randal Quarles, the Fed’s outgoing vice chairman of oversight, said there was no official timetable, but he also told Reuters that two years “sounds right”.

Unlike bank stress tests, which allocate capital, scenario analysis is, by and large, intended to function as a standalone data-gathering exercise and not result in a cost of capital, said the forum’s executives and Campbell.

Nonetheless, critical data would be generated that could pave the way for regulators to introduce capital penalties or other credit restrictions.

In a recent interview with Reuters, JPMorgan CEO Jamie Dimon said he believes a Fed climate assessment is “inevitable” and would eventually lead to additional capital requirements.


Some Democrats in Congress and progressive groups want the Fed to move faster and release an analysis as early as next year, and hope that an imminent reorganization of the Central Bank Council could speed things up.

“What you have now would certainly allow you to run some level of scenarios on both physical and transitional risks,” said Phillip Basil, director of banking policy at progressive think tank Better Markets and a former Fed official.

Republicans say the Fed shouldn’t be pushing climate change, fearing oil and gas companies may lose access to capital.

“They are very sensitive to policy on this,” said one of the industry executives, referring to Fed officials.

The Fed is an independent agency, and Chairman Jerome Powell, who could soon be appointed to the role, said the central bank’s mandate is to focus only on risk management issues.

“The Fed should conduct a scenario analysis and an analysis of the impact of the climate on the financial system in general and be rigorous and analytical,” Quarles told Reuters.

“There’s a lot to be done to develop something like this.”


Climate risk testing is highly complex and new territory for the Fed, which is looking closely at what its counterparts in Europe and elsewhere are doing, people said.

The Netherlands and France have climate-tested their banks, and the Bank of England and the European Central Bank plan to do so in the coming months.

By and large, these reviews assess how bank balance sheets would perform under a set of economic scenarios based on how aggressively policymakers are acting to contain the rise in temperature.

For example, the Bank of England’s upcoming analysis includes two scenarios in which both premature and hasty policy responses ultimately help limit the average global temperature rise to 1.8 degrees Celsius above pre-industrial levels, and a third scenario in which inaction leading to a 3.3 degree Celsius rise in Celsius.

So far, no country has gone so far as to link bank capital requirements directly to results.

Last year the Fed joined the Network for Greening the Financial System, an international group of regulators that developed a number of scenarios on which the central bank could rely.

Much of the supervisory discussion has focused on how banks can identify, analyze, and model both financial and non-financial data. A senior executive said lenders faced challenges with outdated and retrospective weather data and tracking emissions related to customers’ downstream suppliers, among other challenges.

Fed Governor Lael Brainard, who could potentially replace Powell or Quarles, admitted the data challenges in a speech last month but said regulators have to start somewhere.

It is unclear whether the Fed would follow its foreign competitors and publish the aggregated results of all major banks instead of individual institutions, multiple sources said.

Campbell said it was also unclear whether the Fed would give banks specific climate change scenarios similar to the economic scenarios it develops for annual bank stress tests, or just general parameters.

He added that it should not be taken for granted that the Fed would ultimately attempt to use scenario analysis to allocate capital, as such exercises attempt to assess risk over a much longer time horizon and with far larger assumptions than traditional bank stress tests.

However, some bankers disagree.

“If you figure out what you really want to stress out and it’s really real, you will likely be putting capital in,” Dimon said.

Reporting by Pete Schroeder; additional coverage from Matt Scuffham; Adaptation by Michelle Price and Edward Tobin

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