Fed calls for closer monitoring of climate risks in proposed guidelines

The Federal Reserve Board of Governors has proposed new guidelines for how banks with more than $100 billion of assets should manage climate-related financial risks.

The Fed is seeking public comment on the new framework, which calls for banks to establish standards for assessing the risks posed by climate change as well as related changes to policy, market sentiment and technology, known collectively as transition risks. 

"Weaknesses in how financial institutions identify, measure, monitor, and control potential climate-related financial risks could adversely affect financial institutions' safety and soundness, as well as the stability of the overall financial system," the proposal reads. "The Board is therefore seeking comment on draft principles that would promote a consistent understanding of how climate-related financial risks can be effectively identified, measured, monitored, and controlled among the largest institutions, those with over $100 billion in total consolidated assets."

Bloomberg News

Released Friday afternoon, the proposal calls for enhanced tracking of climate risks and disclosure of data to the Fed. It also calls for banks to implement a host of internal controls aimed at monitoring and addressing climate-related financial risks as they arise.

The framework mirrors similar guidelines released by the Office of the Comptroller of the Currency and the Federal Depository Insurance Corp. in 2021 and 2022, respectively. It calls for existing risk management protocols and practices to be expanded to focus specifically on climate-related risks.

The Fed's proposal does not outline any additional capital requirements, but it does encourage bank boards of directors and management teams to create liquidity plans for dealing with climate-related risks.

Climate-based regulation has been a contentious topic within bank regulatory circles. Some groups worry that supervising agencies haven't done enough to protect the financial system from risks related to extreme weather and changing policies. Others say the most relevant risks related to climate change are already being tracked by banks, thus rendering additional regulation unnecessary. This ideological divide is present within the central bank, too.

Fed Gov. Christopher Waller voted against issuing the proposed guidelines, arguing that climate-related financial risk did not merit stand-alone regulations from the Fed.

"Climate change is real, but I disagree with the premise that it poses a serious risk to the safety and soundness of large banks and the financial stability of the United States," Waller said in a statement released alongside the proposed guidelines. "The Federal Reserve conducts regular stress tests on large banks that impose extremely severe macroeconomic shocks and they show that the banks are resilient."

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Similarly, Fed Gov. Michelle Bowman also expressed skepticism about the need for new rules related to climate risks. While she voted in favor of seeking public comment on the proposal, she said her final vote will be contingent on the feedback received.

Bowman, who also issued a written statement Friday afternoon, supported the $100 billion asset minimum, stating that such firms already have robust risk management protocols in place. She said the proposals were in line with existing risk management procedures but raised questions about their likely effectiveness and associated costs.

"I look forward to reviewing comments from the public on this proposal," she said. "While I support seeking public comment, this vote does not indicate my support for the finalization of this guidance. I will evaluate any future recommendation to finalize this guidance on its merits."

The framework calls for climate change and transition risks to be examined on six levels: governance; policies, procedures and limits; strategic planning; risk management; data, risk management and reporting, and scenario analysis. 

The proposal notes that scenario analysis should be different from traditional stress testing models that often include near-term transition risks. Scenario testing has been a linchpin of Vice Chair for Supervision Michael Barr's approach to climate-related financial risk since he became the Fed's top regulator over the summer. In September, the Fed announced that it would run a pilot climate scenario test with six of the largest banks in the country next year. 

Overall, the proposed framework urges bank boards and managers to think about climate-related financial risks over a variety of time horizons. It also specifies that banks should monitor risks to credit, liquidity, operations, legal and compliance obligations, as well as other financial and nonfinancial risks that could arise from climate change. 

The public will have 60 days to comment on the proposed guidelines once they are posted on the Federal Register.