As of: 01/18/2023 2:58 p.m
After the ECB carried out a climate stress test in 2022, the US Federal Reserve has now asked the largest American banks to analyze the climate risks. The results should come at the end of the year.
The US Federal Reserve (Fed) has asked the six largest US banks to compile data on how the consequences of climate change and the transition to a lower carbon economy could affect their businesses. The scenario analysis should include the physical risk – for example hurricanes, fire or drought – of your real estate portfolio. In addition, the influence of the transformation on its lending to companies is to be examined, the Fed announced.
However, the pilot is not a forecast or policy and is not necessarily intended to reflect the most likely events. Instead, he should ensure that the financial system is prepared for – and understands – the risks associated with global warming.
52-page guide, but no stress test
“The Fed has a limited but important responsibility regarding climate-related financial risks,” said Vice Chairman for Oversight Michael Barr. The central bank must ensure “that the banks understand and control their main risks – including the financial risks of climate change”.
Bank of America, Citigroup, Goldman Sachs, JPMorgan, Morgan Stanley and Wells Fargo – whose balance sheets have recently been mixed – now have until July 31 to answer the 52-page guide. The Fed finally wants to publish a summary of the results at the end of 2023.
The climate risk analysis differs from the regular “stress tests”. These are carried out by monetary watchdogs as part of their banking supervision to determine whether the banks have sufficient capital to cover losses in the event of an immediate economic shock.
Dilemma between financial stability and legal task
The exercise is a “positive step” in understanding banks’ vulnerabilities, corporate governance and risk controls, Mark Narron, senior director of Fitch Ratings, told Reuters. Dennis Kelleher, president and CEO of Washington-based nonprofit Better Markets, called the measure a “weak start” that lacks two key elements: evaluating performance and the impact of climate shocks on commercial lending.
For Christina Parajon Skinner, professor of economics and law at the Wharton School of the University of Pennsylvania, the pilot project is also a balancing act between protecting the financial system from new risks and complying with the Federal Reserve’s legal requirements. Some members of Congress, especially Republicans, recently called on the Fed to avoid climate policy and focus on fighting inflation.
Other central banks have already conducted climate stress tests
Other central banks are already a step ahead of the Fed. For example, last year the Bank of England (BoE) published its first climate scenario analysis for the UK financial system, assessing both insurers and banks on the physical threats posed by climate change and the burdens of the expected transition to climate neutrality.
The European Central Bank (ECB) also carried out a climate stress test in 2022. The result: the largest financial institutions in the euro zone do not yet have the risks emanating from climate change fully under control. “Euro-area banks urgently need to step up their efforts to measure and manage climate risk,” ECB Banking Supervisor Andrea Enria said when the results were presented in July.
In unfavorable scenarios, environmental losses for the European industry are likely to add up to at least 70 billion euros. However, it reflects “only a fraction” of the actual climate-related risk for the industry, the supervisors warned. 104 financial institutions from the currency area took part in the test, including Deutsche Bank and Commerzbank.