The acting chairman of the Federal Deposit Insurance Corp. (FDIC) Martin Gruenberg addressed the American Bankers Association on Monday with a directive: Climate change already poses a risk to financial institutions today, and that risk will only get worse.
Although he clarified that the FDIC will not confuse itself with determining which companies and sectors banks should engage with – “The FDIC is not responsible for climate policy,” he said. “These types of credit allocation decisions are the responsibility of financial institutions” – he clarifies that banks must consider climate-related financial risks as they do for other risks, and adopt the same approach based on risks “in the evaluation of individual credit and investment decisions”.
This year, the FDIC established an internal task force to cultivate an agency-wide understanding of these risks, and in March posted a request for comment on draft principles that would provide a framework on how to manage climate-related financial risk exposures. This request is similar to the guidance issued by the Office of the Comptroller of the Currency (OCC) in December 2021, and although the FDIC’s comment period ended in June, the comments are still being reviewed.
“[W]We are in the early stages of understanding and managing climate-related financial risks,” Gruenberg said. “[We] need more and better data to better understand exposures to these risks and to develop methodologies to analyze them [and] we need deeper and better dialogue with our counterparts in the United States and with international financial regulators, and in particular with stakeholders across the banking industry.”
Here are five key takeaways from his message on Monday:
1. The pandemic has been a wake-up call that financial crises will not always originate from economic developments or from within the financial system.
Historically, financial crises have stemmed from economic developments, as in the case of the Great Depression or the recession of 2007-2008. The Financial Stability Supervisory Board has called the COVID-19 pandemic “the greatest external shock to hit the postwar U.S. economy.” Gruenberg posited that the FDIC has “learned from the pandemic that exogenous shocks can have a profound impact on the economy and the financial system”, mirroring the October 2021 FSOC report which stated that “climate change will likely be a source of shocks for the financial system in the years to come. »
2. Community banks may face greater climate-related risks than large banks.
While climate-related financial risk presents “unique, serious and unknown risks” for all banks, Gruenberg said, some banks might have more concentrated exposures, likely due to geography. Overreliance on insurance and government support in times of disaster is risky “because these may not be able to offset losses to the same extent as in the past, or may become more expensive. “, did he declare.
“This can emphasize the ability of smaller institutions to mitigate climate-related financial risks,” Gruenberg said.
However, “increased exposures and increased uncertainty should not lead to unreasonable expectations on the part of regulators”, he said. As in other areas of risk, regulators’ expectations will be based on a bank’s size and complexity, and they plan to leverage the experiences of community banks to develop cost-effective risk management approaches.
3. It’s not just the physical risks associated with climate change.
The physical hazards are the most obvious – halls flooded by hurricanes on the coast, branches inaccessible due to wildfires in the west. But there are also transition risks related to climate change, or constraints faced by banks due to changes in public investments, consumer and business preferences, or technologies related to a shift towards reduced carbon dependence.
Long-term physical risks, including rising temperatures and sea levels, could drive migration patterns, the far-reaching effects of which could be “impacts on household wealth, business profitability, local economies and municipalities,” according to a White House report last fall. The increasing physical risks of climate change may influence where individuals decide to set up businesses, prioritizing geographic areas with less physical risk.
Current insurance policies from banks and their customers’ businesses may cover some or all of what is lost during severe weather events, but as the weather gets wilder, more severe and less predictable, these policies may gradually become more experienced or unavailable to cover these events. losses, according to California Insurance Commissioner Dave Jones’ 2018 report on the availability of wildfire insurance.
4. Consumer and investor preferences for climate policy could affect their investments.
Changes in investor and public preferences can support or accelerate the transition to a low-carbon economy, and technological advances are likely to arise to meet these needs.
Therefore, “certain companies or certain sectors may face increased competition or a decline in their revenues, leading to a reduction in profitability and the ability to repay their obligations, as well as a reduction in the value of certain assets. less productive in a low-carbon environment,” he said.
In addition, market demand for “climate-related financial risk assessment and disclosure” may influence investment decisions or lead to a change in market, consumer or investor preferences that “may trigger declines of the value of certain assets or groups of assets”. assets on their balance sheet and contribute to greater volatility in portfolio performance.
5. Now is the time for banks to prepare climate-related financial risk plans and practices.
As a first step, the bank’s board and management should seek to better understand climate-related financial risk and its impact already on customers and the communities they serve, recognizing that impacts may change with time. time. Gruenberg mirrored OCC acting chief Michael Hsu, who made a similar suggestion last November.
“Banks can consider developing robust and appropriate governance frameworks and processes capable of integrating the assessment and management of climate-related financial risks, depending on their size, complexity and risk profile. risk “, Gruenberg said.
Building the internal infrastructure around climate-related risks as early as possible will help these institutions manage risks as they arise.
“Simply put, it’s just good governance to be prepared. And we can prepare now,” he said.