A top Federal Reserve official delivered a stark warning on Thursday morning: Banks and other lenders need to prepare themselves for the realities of a world wracked by climate change, and regulators must play a key role in ensuring that they do so.
“Financial institutions that do not put in place frameworks to measure, monitor, and manage climate-related risks could face outsized losses on climate-sensitive assets caused by environmental shifts, by a disorderly transition to a low-carbon economy, or by a combination of both,” Lael Brainard, one of the central bank’s six Washington-based governors, said in remarks prepared for delivery at an Institute of International Finance event.
Her comments come against a grim backdrop as abnormally cold weather wallops Texas — leaving millions without electricity and underlining that state and local authorities in some places are underprepared for severe weather events, which are expected to become more frequent.
Such disruptions also matter for the financial system: They pose risks to insurers, can disrupt the payment system, and can make otherwise reasonable financial bets dicey. That makes it important for the Fed to understand and plan for them, central bank officials have increasingly said.
Ms. Brainard pointed out that financial companies are beginning to address the risk by “responding to investors’ demands for climate-friendly portfolios,” among other changes. But she added that regulators like the Fed must also adapt. She raised the possibility that bank overseers may need new supervisory tools because of the challenges of climate oversight, which include long time horizons and limited precedent.
“Scenario analysis may be a helpful tool” to assess “implications of climate-related risks under a wide range of assumptions,” Ms. Brainard said, making it clear that scenarios would be distinct from full-fledged stress tests.
She noted that the Fed’s Supervision Climate Committee, which was announced last month, would work “to develop an appropriate program” to supervise banks’s climate-related risks. The Fed is also co-chair of a task force on climate-related financial risks at the Basel Committee on Banking Supervision, a global regulatory group.
Weighing in on climate risks publicly is new territory new for the Fed. Officials spent years tiptoeing around the topic, which is politically charged in the United States. The central bank only fully joined a global coalition dedicated to research on girding the financial system against climate risk late last year, and it has recently seen pushback from Republican lawmakers over the possibility of climate-tied bank stress tests.