FED Proposes Principles for Climate Risk Management at Large Banks
The Federal Reserve Board (FED) proposed principles that would provide a high-level framework for the safe and sound management of exposures to climate-related financial risks for large banking organizations with more than USD 100 billion in total assets. Comments on the proposal must be submitted by February 06, 2022.
The proposed principles address both the physical risks and transition risks associated with climate change and would cover six areas: governance; policies, procedures, and limits; strategic planning; risk management; data, risk measurement, and reporting; and scenario analysis. The principles also describe how climate-related financial risks can be addressed in specific prudential risk areas, including credit, liquidity, other financial risks, operational, legal/compliance, and other non-financial risks. With respect to credit risk the proposal notes that management should consider climate-related financial risks as part of the underwriting and ongoing monitoring of portfolios. Effective credit risk management practices could include monitoring climate-related credit risks through sectoral, geographic, and single-name concentration analyses, including credit risk concentrations stemming from physical and transition risks. As part of the concentration risk analysis, management should assess potential changes in correlations across exposures or asset classes. Consistent with the risk appetite statement of a financial institution, management should determine credit risk tolerances and lending limits related to these risks.
With respect to scenario analysis, the proposal notes that management should develop and implement climate-related scenario analysis frameworks commensurate to size, complexity, business activity, and risk profile of the financial institution. These frameworks should include clearly defined objectives that reflect the overall climate-related financial risk management strategies. These objectives could include, for example, exploring the impact of climate risks on the strategy and business model, identifying and measuring vulnerability to relevant climate-related financial risk factors including physical and transition risks, and estimating climate-related exposures and potential losses across a range of scenarios, including extreme but plausible scenarios. A climate-related scenario analysis framework can also assist management in identifying data and methodological limitations and uncertainty in climate-related financial risk management and assessing adequacy of the climate-related financial risk management framework of an institution. Climate-related scenario analyses should be subject to oversight, validation, and quality control standards, with results of analyses being clearly and regularly communicated to the board and all relevant individuals within the financial institution, including an appropriate level of information necessary to effectively convey the assumptions, limitations, and uncertainty of results.
The principles are designed to help financial institutions’ boards of directors and management make progress toward incorporating climate-related financial risks into financial institutions’ risk management frameworks in a manner consistent with safe and sound practices. The principles are intended to supplement existing risk management standards and guidance on the role of boards and management. The proposed principles are substantially similar to the proposals issued by the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC). FED intends to work with these agencies to promote consistency in the supervision of large banks through final interagency guidance.
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Keywords: Americas, US, Banking, Basel, Credit Risk, Lending, Scenario Analysis, Stress Testing, ESG, Climate Change Risk, Large Banks, US Agencies, FED
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