The Fed has a clear mandate for reducing climate risks

Last week, the Senate Banking Committee heard from Sen. Pat ToomeyPatrick (Pat), Joseph ToomeyConservatives are outraged by Sarah Bloom Raskin’s belief that capitalism is possible Joe Manchin, Washington’s most inept senator Black women seek to build on their gains in the next elections LEARN MORE (R-Pa.) Warned the Federal Reserve against “stray[ing] from its mandate” by addressing “politically-charged areas like global warming.” 

“If this politicization continues unchecked,” the senator threatened, “it will not end well for the Fed.” 

These comments clearly target Sarah Bloom Raskin. President BidenJoe BidenNew York woman arrested for spitting on Jewish children Former Senator Donnelly confirmed as Vatican Ambassador Giuliani associate sentenced for a year in prison in case involving campaign finance LEARN MORE’s nominee to be the Federal Reserve’s chief bank regulator, who has ffentlich called for the institution to ensure a smooth transition to a low-carbon economy without disruptions to the financial system.

Toomey is simply wrong. Addressing banks’ climate risks is core to the Federal Reserve’s legal mandate. To ignore climate change and its risks would be contrary to their congressionally-given mandates. Doing so would not end well for the Fed — or the economy.

Congress understood long ago that a strong economy requires a stable and inclusive banking system. Banks are a way for savers to build wealth and entrepreneurs to start and grow their businesses. They also allow the Federal Reserve target customers. Full employment and a reduction in inflation by transmitting monetary policy decisions to the rest of the economy. Consequently, Congress tasked the Federal Reserve and its fellow federal banking regulators with ensuring banks do not operate in an “Unsound or dangerous condition,” responding to “Emerging threats to the stability of the United States financial system,” and encouraging banks “to help meet the Credit needs” of their communities, among other requirements.

As climate-related risk is a new form, the Federal Reserve must ensure banks can weather the climate crises. Systemic risk that can have severe consequences on financial stability. According to the National Oceanic and Atmospheric Administration, the United States saw “20 separate billion-dollar weather and climate disasters” in 2021 with damages totaling about $145 billion, and there is little doubt those disasters affected the financial system. Banks are exposed to climate-related risks due to acute and chronic physical damage and productivity losses, also known as physical risk. There is also ongoing transition away high-carbon industries, growing legal liability, and transition risk.

Importantly, these twin risks map directly onto the traditional categories of financial risks that banks face — and must manage — with every loan. For example, a farmer borrowing money to buy a tractor might not be able repay the loan if her crops get destroyed by strong storms (i.e. Credit risk). A loan to an oil company or gas company might not be repaid due to the rising costs of solar energy and the demise of fossil fuel infrastructure (i.e., market risks). Or a bank’s headquarters and computer servers may be at risk from extreme flooding or wildfires (i.e., operational risk). 

No matter if a bank has been shut down due to climate change, theft or other mismanagement, it can’t take deposits, make loans or support the economy. And despite Toomey’s claims to the contrary, climate risks are squarely within the Federal Reserve’s statutory mission of ensuring a stable financial system.

Because climate change poses risks similar to those banks routinely face — such as credit, market, and operational risks — the Federal Reserve can take routine actions to ensure that banks are well-equipped to tackle climate change, including issuing climate supervisory guidance and conducting climate scenario analyses.

Banks receive regular supervision guidance from the Federal Reserve to help them identify emerging risks and provide examples of ways to reduce those risks. The Federal Reserve should issue supervisory guidance to help banks understand climate risks and offer options for mitigating them. Federal Reserve examiners annually rate banks based on a number factors, known as CAMELS rating. The Federal Reserve should update its examination manuals so that it explains how climate risks will be included in those ratings.

The Federal Reserve began regularly testing large banks in order to determine their vulnerability to stress-related failures after 2008’s financial crisis. Because the potential consequences to the financial system from climate change are similar to those of financial crises — failing banks leading to a pullback of credit — the Federal Reserve should perform climate scenario analyses to evaluate banks’ susceptibility to failure due to climate risks in the future.

Importantly, the Federal Reserve cannot legally tell banks to sell off certain lines of business, like loans to oil and natural gas companies. It can and should, however, help banks understand the risks they face, and prevent those risks from spreading through the financial system and into the real economy. Fortunately, many of the nation’s largest banks, including Bank of America and JPMorgan Chase, and some small- and mid-size banks have made the It is a voluntary decision to decarbonize without the need for regulatory pressure.

Toomey would prefer that the Federal Reserve avoid politics and follow its statutory mandate. But, to do so, officials must address climate risks in the banking system. The Federal Reserve leadership has recognized this fact, based upon extensive research. Jerome PowellJerome PowellConservatives are outraged by Sarah Bloom Raskin’s belief that capitalism is possible Biden selects Sarah Bloom Raskin; two others are selected for the Fed board Overnight Energy & Environment — Earth records its hottest years ever LEARN MOREAnswered a question regarding climate risks It is possible to state, “We have a role to play. It’s a narrow one, but an important one, and that is it relates to our existing mandates.”

Todd Phillips is the Director of Financial Regulation and Corporate Governance at the Center for American Progress.