October 12, 2022

Climate Risk Management Continues to Be a Focus for US FDIC

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On October 3, 2022, the acting chairman of the US Federal Deposit Insurance Corporation (“FDIC”) gave a speech on the FDIC’s evolving expectations for climate risk management at the banks that it regulates.1 The speech is notable because it indicates that the FDIC now expects community and mid-size banks to develop climate-related financial risk management practices. While these practices may be tailored for the smaller, less complex risk profile of community and mid-size banks, they still will require considerable attention by management of banks of all sizes.

In this Legal Update, we discuss the FDIC’s efforts on climate risk management and how the October 3 speech represents an expansion of supervisory expectations.

Background

The FDIC is the primary regulator of state-chartered banks that are not members of the Federal Reserve System, state savings associations, and insured branches of foreign banks.2 These banks, by and large, are smaller institutions, with over 3,000 FDIC-regulated institutions having less than $100 billion in assets and only six having more than $100 billion in assets. Most larger banks are regulated by the Office of the Comptroller of the Currency (“OCC”) or the Federal Reserve Board.

In March 2022, the FDIC released draft principles for managing exposures to climate-related financial risks at banks with over $100 billion in total assets. This proposal largely mirrored an earlier proposal from the OCC and, as noted in the October 3 speech, has yet to be finalized. The FDIC also joined the Network for Greening the Financial System, which is a global group of regulators that exchange best practices, ideas, and research related to environmental and climate risk management in the financial sector.

October 3 Speech

The October 3 speech largely restates existing talking points on the importance of understanding and managing climate-related financial risk. For example, it reiterates that the FDIC will not be involved in determining which companies or sectors financial institutions should do business with. Similarly, it discusses how supervisory expectations for climate-related financial risks will be tailored to each institution’s risk profile.

However, it also makes three new points that financial institutions should pay attention to.

  • First, it states that FDIC-regulated institutions should not become overly reliant on insurance and government assistance to address climate-related financial risks. The FDIC believes that insurance policies that cover losses related to severe weather events may, over time, become more expensive or unavailable to cover losses for a particular geographic area or business activity. Similarly, financial institutions should not become dependent on assistance from the federal government to cover the costs associated with many severe weather events. These statements indicate that the common risk management technique of risk transfer may not be appropriate for climate-related financial risks. Financial institutions may need to explore other techniques, such as risk avoidance or risk mitigation.
  • Second, it states that community and mid-size banks should seek to better understand and consider their own unique climate-related financial risk and how it may impact them. As indicated above, the proposed climate risk management principles are targeted at larger institutions, so this statement constitutes an expansion of the FDIC’s supervisory expectations for climate risk management at smaller institutions. And even more notable is the fact that the October 3 speech cites an OCC document for large banks as an example of the types of climate risk questions that community and mid-size banks should be considering.
  • Third, it indicates that the FDIC does not view climate scenario analysis expectations as leading to capital requirements based on climate risk. Specifically, the October 3 speech states that “scenario analysis is not a stress testing exercise and will not have regulatory capital implications.” This should be welcome by the industry, particularly given the Federal Reserve Board’s recent announcement of a climate scenario analysis exercise for larger banking organizations.

Conclusion

Community and mid-size banks should begin to consider how climate-related financial risks affect their activities. While they may determine that these risks are immaterial or inapplicable based on their specific risk profile, the October 3 speech indicates that FDIC examiners will, at a minimum, expect to see documentation of those determinations.

Similarly, financial institutions of all sizes should prepare for second-guessing of risk management determinations. While the regulators are unlikely to explicitly tell a bank not to make a particular loan, the statements in the October 3 speech that discourage reliance on insurance policies already show a willingness to second-guess decisions by bank management.

Finally, financial institutions should continue to expect banking regulators to impose new and more detailed supervisory expectations on the management of climate-related financial risks. This topic remains in the regulatory cross-hairs and will require constant revision to bank risk management practices.

 


 

1 Remarks by FDIC Acting Chairman Martin J. Gruenberg on the American Bankers Association Annual Convention “The Financial Risks of Climate Change” (Oct. 3, 2022), https://www.fdic.gov/news/speeches/2022/spoct0322.html.

2 12 U.S.C. § 1813(q)(2).

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