The Federal Reserve building is seen before the Federal Reserve Board is expected to signal plans to raise interest rates in March as it focuses on fighting inflation in Washington January 26, 2022.
Joshua Roberts | Portal
The six largest banks in the US have until the end of July to chart the impact climate change could have on their operations, according to details of a pilot program the Federal Reserve unveiled on Tuesday.
As part of the review, institutions are expected to show the expected impact that events such as floods, wildfires, hurricanes, heat waves and droughts could have on their loan portfolios and commercial real estate holdings. A hypothetical scenario focuses on events in the US Northeast
Although the two exercises share similarities, the climate scenario tests are considered separately from mandatory bank stress tests, which examine preparedness in the event of financial and economic crises.
“The Fed has narrow but important responsibilities related to climate-related financial risks — to ensure banks understand and manage their material risks, including financial risks from climate change,” said Michael S. Barr, the Fed’s vice chairman for oversight. “The exercise we’re launching today will improve the ability of regulators and banks to analyze and manage emerging climate-related financial risks.”
The analysis lasts at least three years.
A late 2020 Financial Stability Report first discussed the possibility of the Fed assessing how prepared the institutions it oversees are to the economic impacts of climate change. That came a year after Fed Vice Chair Lael Brainard first raised the issue.
However, Chair Jerome Powell recently vowed that the central bank would not become a “climate politician” despite the efforts of the new program.
The analysis takes a two-pronged approach, considering a “physical risk” perspective, or the damage to people and property from unexpected climate-related events and “transition risks” associated with the costs of transitioning to a zero-emission economy by 2050.
Participating banks include Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley and Wells Fargo. The filing deadline is July 31, with a summary expected to be released by the end of the year but not including information on specific banks’ responses.
The report released on Wednesday did not outline a more specific scenario for banks to address. But it said that would include an examination of the impact of “risk scenarios of varying severity” in the Northeast on residential and commercial property portfolios.
In addition, banks are asked to “consider the impact of additional physical risk shocks on their real estate portfolios in another region of the country.”
The Transition Risk portion is intended to focus on how corporate lending and commercial real estate would be affected by the move to net-zero greenhouse gas emissions by 2050.
The final report focuses on aggregated information from banks on how they integrate climate risks into their financial plans. No estimates are made of the total potential losses from the hypothetical events.