The Federal Reserve Board consults on climate-related financial risk management for large banking organizations

On Dec. 8, 2022, the Federal Reserve Board (Fed) published its proposed principles to provide a high-level framework for managing climate-related financial risks.

This proposal is for large banking organizations with consolidated total assets greater than USD$100 billion. However, it was recognized many other financial institutions (FIs) would benefit from this guidance as they work to consider climate-related financial risks in their risk management, strategic planning and decision-making. 

The principles proposed by the Fed are aligned with proposals by the Comptroller of the Currency (OCC) and Federal Deposit Insurance Corporation (FDIC) published in December 2021 and March 2022, respectively. This was to promote consistency in supervision and provide clear guidance around this topic.

Summary of proposed principles

The proposed high-level framework for climate-related financial risk management covers six areas, of which the principles and expectations therein are summarized below:

1. Risk governance framework:

  • To ensure sufficient oversight on risk-taking activities and management of climate-related financial risks, a board should:
    • Understand the impact of these risks and clearly communicate to management the information it needs to understand this
    • Allocate appropriate resources around managing these risks
    • Allocate accountability for managing these risks across existing organizational structures or establish new structures
    • Determine how incorporating these risks could impact compensation policies
  • Management is responsible for implementing processes for managing climate-related financial risk in accordance with a board’s strategic direction. Management is to ensure:
    • Roles and responsibilities are adequately defined and allocated
    • Accountabilities are upheld
    • Sufficient expertise exists to effectively manage these risks
    • Responsibilities and lines of communication for any dedicated climate risk organizational structure are clearly defined and adequately established

2. Policies, procedures and limits are to incorporate climate-related financial risks. They should be updated to reflect the distinctive characteristics of these risks and changes to the FI’s operating environment or activities.

3. Strategic planning – Board and management are expected to consider material climate-related financial risk when setting overall business strategy, risk appetite and capital plan. The potential impacts of these risks across different time horizons should be considered, as well as how these affect FI’s stakeholders, such as low-to-moderate income and other disadvantaged households and communities.

4. Risk management – As part of their overall risk management framework, FIs are expected to develop processes, tools and approaches to identify, measure, monitor and control climate-related financial risks. Material climate-related financial risk should be clearly identified, align with the FI’s risk appetite, and be supported by appropriate metrics and reporting processes. The proposal sets out high-level principles of how climate-related financial risks can be incorporated into credit, market, operational and liquidity risks.

5. Data, risk measurement and reporting – Climate-related financial risk information should be embedded into FIs’ internal reporting, monitoring and escalation processes. Given the fast-evolving nature of data, risk measurements, modeling methodologies and reporting, FIs should closely monitor developments in these areas and incorporate them as appropriate.

6. Scenario analysis – Management is expected to develop and implement a proportionate climate-related scenario analysis framework. This framework should include clearly defined objectives and explore impacts of the climate-related financial risks on the FI’s strategy and business model. This analysis should be subject to oversight and validation standards, with the results sufficiently communicated to board and management.

Next steps

The Fed’s consultation closes for comments on Feb. 6, 2023. Based on the Fed governors’ statements published alongside the consultation, it’s not clear whether final guidance will be released afterwards.

Fed Governor Christopher Waller doesn’t support issuance of final guidance on the premise that he disagrees climate change poses a serious risk to the safety and soundness of large banks, while Fed Governor Michelle Bowman would consider issuance of final guidance following evaluation of the costs and benefits of any new expectations.

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The information provided here is for general guidance only, and does not constitute the provision of tax advice, accounting services, investment advice, legal advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal or other competent advisers.