On March 23, 2021, Federal Reserve Board (FRB) Governor Lael Brainard announced that the FRB had created a Financial Stability Climate Committee (FSCC) to identify, assess, and address climate-related risks to financial stability.
The FRB previously announced1 the establishment of a new Supervision Climate Committee (SCC) to strengthen the FRB’s capacity to identify and assess financial risks from climate change and to develop a program to ensure the resilience of supervised financial institutions to those risks. Governor Brainard explained that the SCC's micro-prudential work is intended to ensure the safety and soundness of financial institutions and constitutes one core pillar of the FRB's framework for addressing the economic and financial consequences of climate change.
In contrast, the FSCC will examine the macro-prudential aspects of climate change, including the potential for climate-generated economic shocks and how climate change could “amplify these shocks and cause broader knock-on effects that could harm households, businesses, and communities.” As part of its efforts to enhance the resiliency of the financial system, the FSCC will also coordinate with the SCC as well as the Financial Stability Oversight Council and its member agencies to develop an integrated approach to climate change risk. The FSCC’s focus on financial stability constitutes the second pillar of the FRB’s climate change framework.
Governor Brainard elaborated on the nature of the macro-prudential risks presented by climate change, noting their similarities to other exogenous financial stability shocks (such as COVID-19) but also their significant differences. Unlike traditional, transitory economic shocks, climate change presents an “ongoing, cumulative process, which is expected to produce a series of shocks.” Governor Brainard recognized that quantifying the risks and implications of climate change to the economy is “extremely difficult.” Nevertheless, she argued, the assumption of climate risk by the financial system could amplify shocks, especially if market participants misprice this risk and the climate risks are correlated across financial institutions and the economy. Even though market participants can use property and casualty insurance and other risk mitigation tools to hedge climate-related risks, the financial system could be vulnerable to undisclosed and unhedged climate-related risks that could be triggered by adverse weather or other shocks. She pointed to insurance companies pulling back from covering areas in California and Florida due to heightened wildfire and flood risks as an example of how climate change will have a macro-prudential impact on the US economy.
Governor Brainard stated that the FRB continues to contribute to the Financial Stability Board’s efforts to coordinate globally the adoption of climate change standards, including with respect to identifying data gaps and developing climate disclosure standards. She also noted that the FRB will be co-chairing the Basel Committee’s Task Force on Climate-Related Financial Risks.
The FRB’s approach to climate change risks was also the subject of questions by several members of Congress to Treasury Secretary Janet Yellen and FRB Chair Jerome Powell during their appearances before the House Committee on Financial Services on March 23, 2021, and the Senate Banking Committee on March 24, 2021. In his testimony, Chair Powell emphasized the preliminary nature of the FRB’s assessment of climate risk and that its work derives from the FRB’s statutory mandates to supervise banks and other financial institutions and to address risks to financial stability. In her answers, Secretary Yellen said the “world faces a profound crisis in connection with climate,” and emphasized that, therefore, the federal government had a responsibility to have financial institutions account for climate risk. But neither was willing to share any specifics regarding how this might be manifested in regulatory or other supervisory requirements.
Given the complexity of the task and the adverse micro- and macro-prudential consequences of improper calibration of the risks (as well as the absence of explicit statutory authority to address climate change through financial regulation), Chair Powell was understandably circumspect in delineating the ultimate outcome of the FRB’s ongoing climate change work. Nevertheless, his remarks—and especially Secretary Yellen’s and Governor Brainard’s—demonstrate that the Biden administration is moving forward with substantial new climate change regulation. As Governor Brainard’s remarks illuminated, the ultimate goal is the establishment of a regulatory framework (which includes risk management, scenario analysis, disclosures, and remediation plans) that addresses the risk climate change presents to the safety and soundness of individual institutions as well as the overall economy.