The Federal Reserve Bank of New York (NY FED) released two staff reports on climate-related risks for financial institutions. The first report discusses US banks’ exposures to transition risks from climate change. The second report discusses the design of climate stress tests done to assess and manage macro-prudential risks from climate change in the financial sector. The Office of Financial Research (OFR) also announced that it is developing an expanded and enhanced version of its interagency data and analytics platform, following a successful pilot, which will be named the Joint Analysis Data Environment (JADE). JADE will support comprehensive financial-stability research by providing a platform to integrate and analyze a broad spectrum of financial and other relevant data. The OFR anticipates that the initial version of JADE will be released during the second half of 2023. The OFR plans to gradually expand this collaborative space for use by other Financial Stability Oversight Council (FSOC) regulators and includes additional data.
The US Banks’ Exposures to Climate Transition Risks report analyzes how banks may be affected by policies and scenarios designed to promote the transition to a low-carbon economy (in contrast to bank exposure to the physical risks associated with climate change). The FRBNY uses loan-level data from the commercial lending portfolios of larger financial institutions combined with general sectoral estimates to estimate bank exposure to transition policies and scenarios under three models. It finds significant variation in bank exposures based on different models used, but, even despite the variation, while banks’ exposures to transition risks are significant, they are not very large—no higher than 16% of their loan portfolio even in the most severe scenario. There is also evidence that many banks have exited from lending to industries at the highest risk of being adversely impacted by a transition to a low-carbon economy, which may be driven by banks’ attempts to reduce their exposures to climate transition risks. The report suggests the need for additional research on the nexus between financial stability and climate risks. It recommends that regulators analyze how borrowers’ exposure to climate risks will impact their access to funding going forward, whether their credit profile fully reflects these risks, and where instruments related to climate risk are in the financial system may also be helpful.
The Climate Stress Testing report assesses the potential for banks to conduct stress testing to manage climate-related risks to financial stability. It identifies physical risk (that is, the risk to economic activity from physical manifestations of climate change) and transition risk (i.e., the effects on economic activity from regulatory interventions in response to climate risk) as the types of climate change risk that could impact economic activity. Since transition risks result from the dynamic decisions of policymakers who consider costs and benefits while considering political feasibility, the economists argue that additional research on political economy considerations would be helpful in defining more plausible transition risk scenarios. The economists also call for a deeper analysis of the interactions between climate change and the overall economy to better model the economic environment that accompanies physical climate risk realizations. The report suggests that while existing research indicates that climate risks are already priced across asset classes, it is unknown whether the risks are adequately priced (i.e., how quickly investors may update beliefs in response to information about future climate risk realizations). Overall, the Climate Stress Testing report concludes that additional research is required to identify better models and data, which suggests that the Federal Reserve may still be far from using climate stress testing to set capital requirements.
Keywords: Americas, United States of America, Banking, Climate Change Risk, Physical Risk, Transition Risk, ESG, Climate Data and Analytics Hub, OFR, FED, FSOC
Hasan leads Moody’s Analytics ESG methodology development. He is expert on carbon transition, nature related risks and is a guest lecturer at ESSEC Business school on sustainable finance.
Dr. Denton provides industry leadership in the quantification of sustainability issues, climate risk, trade credit and emerging lending risks. His deep foundations in market and credit risk provide critical perspectives on how climate/sustainability risks can be measured, communicated and used to drive commercial opportunities, policy, strategy, and compliance. He supports corporate clients and financial institutions in leveraging Moody’s tools and capabilities to improve decision-making and compliance capabilities, with particular focus on the energy, agriculture and physical commodities industries.
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