Climate and banks: Wall Street titans Goldman Sachs, JPMorgan Chase, Morgan Stanley, Citigroup, Wells Fargo and Bank of America have been tapped by the US Federal Reserve Bank (Fed) to participate in its inaugural climate scenario exercise.
The news is not entirely surprising for those paying attention. The Fed already indicated in October 2021 that it would be “developing a programme of scenario analysis to evaluate the potential economic and financial risks posed by different climate outcomes”.
The climate pilot is set to commence early 2023 and the results are not expected until the end of the year. The central bank further indicated that at the beginning of the exercise, it would “publish details of the climate, economic and financial variables that make up the climate scenario narratives”.
Climate and banks
The Fed described the scenario analysis as “exploratory in nature” and that it would not have “capital consequences”. In practical terms, this means that the Fed’s climate stress test is entirely distinct and separate from bank stress tests which relate to the question of whether a financial institution has sufficient capital to continue lending during severe recessions.
The intention is that over the course of the pilot, participants will analyse the impact of various scenarios on specific portfolios and business strategies. The Fed will then come in and engage with the firms and work collaboratively to enable them to construct robust climate risk management practices.
At this early stage, details remain scant and more information is expected to become available as the pilot goes live early next year.
The Fed isn’t the only central bank exploring the impact of climate risks in the financial sector. It joins over 30 other central banks – including the Bank of England, Bank of Japan and European Central Bank – who are themselves at various stages of conducting a climate scenario analysis.
The announcement has been met with a healthy mix of opinions. Some have described the move as a “welcome first step” and “just in time”.
Others have been more sceptical, particularly in relation to the Fed’s expanding mandate which is broadly categorised as relating to three issues: inflation, employment and financial stability.
Bank lobbying group the Bank Policy Institute, has opposed the program, describing the exercise as “disproportionate to the risk that the climate may pose to large banks”.
Republican opposition have also expressed their concerns, outlining in a letter last year that it doubted the “purpose and efficiency of climate-related banking regulation and scenarios because the Fed lacks jurisdiction over and expertise in environmental matters”.
Irrespective of the differing opinions, the Fed is going ahead. Is it just more jawboning from a central bank with little practical significance or is there something deeper at play? What are the climate risks to banks and how big a problem do they really pose? Are banks going to be fine or would they go down the tube in the event of a climate meltdown? There’s plenty to speculate about at this stage with no real sense of what lies next. Details will be released in early 2023 and hopefully they will point us in the right direction.