Janet Yellen, the U.S. Treasury Secretary, has announced that she will be leading an effort by some of the top regulators in the country to determine the potential risks posed to the financial system by climate change. The regulatory review will be conducted by the Financial Stability Oversight Council (FSOC), chaired by the Treasury Secretary and regulators such as the Securities and Exchange Commission (SEC) and Federal Reserve System.
The review comes on the heels of an executive order President Joe Biden signed on May 20 regarding climate-related financial risks. The FSOC was established in 2010 in the aftermath of the 2009 Financial Crisis and is tasked with identifying and monitoring excess risks to America’s financial system arising from the activities of financial institutions.
“The current financial reporting system is not producing reliable disclosures. We also need consistency of reporting frameworks over time, as well as comparability across firms and jurisdictions, providing the useful information that investors need to make informed decisions,” Yellen said in her remarks at the Venice International Conference on Climate on July 7.
Yellen went on to state that climate change introduced “new and increasing types of risk,” including physical threats like natural disasters and “so-called transition risks” that accompany policies needed to address climate change. She said that the risks challenge a critical function of the financial system – “ensuring that risk is borne by investors and institutions well placed to manage it.”
According to a report by the Associated Press, many banking executives are “concerned” that the Biden administration could end up creating more regulatory oversight. This would raise the cost of operations and diminish the ability of banks to lend money.
Back in December, a group of 50 Republicans had written a letter to the leadership of the Federal Reserve after the agency proposed “introducing climate change scenarios into its supervisory stress tests of regulated banks.” The authors said that since any “meaningful effects” of climate change would take decades to materialize, banks would be hard-pressed to “accurately forecast stresses over that length of time.”
“A lack of historical data on the relationship between changing weather patterns and financial stress would complicate the prospect of stress testing climate change scenarios. Current supervisory stress tests rely on large amounts of data related to credit losses across varying market conditions,” the letter said.
“The same quantity and granularity of data does not exist for climate-related financial stresses, and the available data may have gaps or a disqualifying level of subjectivity,” it continued. Republicans also raised concerns about “politicizing access to capital” and “choking off funding” for industries like coal, oil, and gas with the introduction of climate change stress tests.
In her remarks at Venice, Yellen talked about engaging international financial institutions like the Multilateral Development Banks (MDB) and the International Monetary Fund (IMF) to develop economic and financial policies “to achieve our climate goals.” She also revealed her intention to meet the heads of MDBs to ensure that they “align their portfolios with the Paris Agreement and net-zero goals as urgently as possible.”
Yellen’s announcement followed a July 9 executive order from Biden aimed at “promoting competition” among various business sectors of the American economy, including the banks. The order stated, “Today President Biden is taking decisive action to reduce the trend of corporate consolidation.”
However, the order received strong criticism from several banking professionals. Greg Baer, CEO, and President of Bank Policy Institute (BPI) dismissed the idea that the banking industry was somehow less competitive. “By any analysis, banking is among the most competitive, least concentrated industries in America,” Baer said in a statement.
A July 2021 report published by the Financial Stability Institute (FSI), an entity established by the Bank of International Settlements (BIS) and the Basel Committee on Banking Supervision, states that there are no “well-established, common practices” regarding climate stress tests in various nations. FSI admitted that the tests are only useful for “imperfectly” sizing potential climate risks to banks, but could still be used to make business decisions.
“While there are currently limits to quantifying the impact of climate risk, the ability to reliably measure climate-related exposures and their potential losses is essential to promote efficient risk management, and the safety and soundness of the financial system. Pilot stress test exercises should be seen as a first key step towards that goal,” the report stated.
In June, the 11th annual EY/IIF global bank risk management survey was published, showing almost 91 percent of Chief Risk Officers (CROs) of private banks viewed climate change as a major emerging risk over the next five years. Almost 50 percent saw climate change as requiring their urgent attention over the next 12 months. The survey was conducted in 88 financial institutions across 33 nations.