The Fed has a clear mandate to mitigate climate risks

During a Senate Banking Committee hearing last week, Ranking Member Sen. Pat ToomeyPatrick (Pat) Joseph ToomeyConservatives are outraged that Sarah Bloom Raskin actually believes in capitalism Meet Washington’s most ineffectual senator: Joe Manchin Black women seek to capitalize on gains in upcoming election MORE (R-Pa.) warned the Federal Reserve against “[ing] of his mandate” by addressing “politically charged areas such as global warming”.

“If this politicization continues unchecked,” threatened the senator, “it won’t end well for the Fed.”

These comments are clearly aimed at people like Sarah Bloom Raskin, President BidenJoe BidenNew York woman arrested after allegedly spitting on Jewish children Former senator Donnelly confirmed as associate of Vatican ambassador Giuliani sentenced to one year in prison in campaign finance case MORE‘s appointment as the Federal Reserve’s chief banking regulator, who has publicly called on the institution to ensure a smooth transition to a low-carbon economy without disrupting the financial system.

Toomey is simply wrong. Banks’ climate risk management is central to the Federal Reserve’s legal mandate. In fact, ignoring climate change and the risks it poses would be contrary to their congressional mandates. It wouldn’t end well for the Fed — or for the economy.

Long ago, Congress recognized that a strong economy needs a strong and inclusive banking system. Banks help savers build wealth, provide loans to entrepreneurs to start and grow businesses, and allow the Federal Reserve to target full employment and reduce inflation by transmitting monetary policy decisions to the rest of the world. ‘economy. Consequently, Congress has instructed the Federal Reserve and its fellow federal banking regulators to ensure that banks do not operate in an “unsafe or unhealthy condition”, to respond to “emerging threats to the stability of the US financial system” and to encourage banks “to help meet the credit needs” of their communities, among other requirements.

Ensuring that banks can weather the climate crisis is essential for the Federal Reserve to meet these legal obligations, because climate-related risks are a new form of systemic risk that can have serious consequences for financial stability. According to the National Oceanic and Atmospheric Administration, the United States experienced “20 separate billion-dollar weather and climate disasters” in 2021 with damages totaling approximately $145 billion, and there is no doubt that these disasters have affected the financial system. Banks are exposed to climate-related risks due to acute and chronic physical damage and productivity losses, known as physical risk, as well as the ongoing transition away from carbon-intensive industries and liability increasing legal risk, known as transition risk.

Importantly, these twin risks correspond directly to the traditional categories of financial risks that banks face – and must manage – with every loan. A farmer who borrowed to buy a new tractor, for example, may be unable to repay the loan if his crops are destroyed by increasingly severe storms (ie, credit risk). Or a loan to an oil and gas company may not be repaid as solar energy costs become cheaper and fossil fuel infrastructure becomes obsolete (i.e. market risk) . Or, a bank’s head office and computer servers may be threatened by extreme flooding or forest fires (i.e. an operational risk).

Whether a bank has failed due to climate change, theft, or simple mismanagement, it cannot take deposits, make loans, or otherwise support the economy. And despite Toomey’s assertions to the contrary, climate risks fit squarely within the Federal Reserve’s statutory mission to ensure a stable financial system.

Because climate change presents similar risks that banks routinely face — such as credit, market, and operational risk — the Federal Reserve can take routine steps to ensure banks are well equipped to address climate change, including by issuing climate monitoring guidelines and conducting climate action. scenario analyses.

The Federal Reserve regularly provides banks with supervisory guidance to identify developing risks that banks face and offers examples of practices that can be used to reduce those risks. As banks begin to address climate change, the Federal Reserve should issue prudential guidance to help them understand the climate risks they face and options for mitigating those risks. And because Federal Reserve examiners assess banks on a number of factors each year, known as CAMELS ratings, the Federal Reserve should update its examination manuals to detail how its examiners will incorporate climate risks. in these ratings.

Similarly, after acknowledging that the failure of some banks during the 2008 financial crisis could harm the broader financial system and the real economy, the Federal Reserve began routinely testing large banks to understand their vulnerability to the bankruptcy in times of crisis. Since the potential consequences of climate change on the financial system are similar to those of financial crises – failing banks leading to a decline in credit – the Federal Reserve should perform climate scenario analyzes to assess the vulnerability of banks to failure. due to climate risks in the future.

It’s important to note that the Federal Reserve cannot legally tell banks to divest entirely from certain lines of business, such as lending to oil and gas companies. What it can and should do, however, is ensure that banks understand the risks they face and help prevent those risks from leading to bank failure and spreading to the rest of the financial system and of the real economy. Fortunately, many of the nation’s largest banks, including Bank of America and JPMorgan Chase, and some small and medium-sized banks have made the voluntary decision to decarbonize without the need for regulatory pressure.

While Toomey wants the Federal Reserve to eschew politics and stick to its statutory mandate, that requires officials to address climate risks within the banking system. Fortunately, Federal Reserve leadership recognizes this, based on extensive and thorough research: During his renomination hearing last week, the Chairman Jerome PowellJerome PowellConservatives are outraged that Sarah Bloom Raskin actually believes in capitalism Biden selects Sarah Bloom Raskin, two others for Fed board Overnight Energy & Environment – Earth Records Hottest Years Ever MORE responded to a question about climate risks by saying, “We have a role to play. It’s a narrow but important question, and that’s because it relates to our existing mandates.

Todd Phillips is Director of Financial Regulation and Corporate Governance at the Center for American Progress.

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