A top Federal Reserve official issued a stark warning on Thursday morning: Banks and other lenders need to prepare themselves for the realities of a world racked by climate change, and regulators must play a key role in ensuring that they do.
“Climate change is already imposing substantial economic costs and is projected to have a profound effect on the economy at home and abroad,” Lael Brainard, one of the central bank’s six Washington-based governors, said at an Institute of International Finance event.
“Financial institutions that do not put in place frameworks to measure, monitor and manage climate-related risks could face outsized losses on climate-sensitive assets caused by environmental shifts, by a disorderly transition to a low-carbon economy or by a combination of both,” she continued.
The grim backdrop to her comments is the abnormally cold weather walloping Texas — leaving millions without electricity and underlining the fact that state and local authorities in some places are underprepared for severe weather that is expected to become more frequent.
Such disruptions also matter for the financial system. They pose risks to insurers, can disrupt the payment system and make otherwise reasonable financial bets dicey. That is why it is important for the Fed to understand and plan for them, central bank officials have increasingly said.
Ms. Brainard pointed out Thursday that financial companies were addressing the risk by “responding to investors’ demands for climate-friendly portfolios,” among other changes. But she added that regulators like the Fed must also adapt. She raised the possibility that bank overseers might need new supervisory tools, given the challenges associated with climate oversight, which include long time horizons and limited data due to the lack of precedent.
“Scenario analysis may be a helpful tool” to assess “implications of climate-related risks under a wide range of assumptions,” Ms. Brainard said, though she was careful to distinguish that such scenarios would be distinct from full-fledged stress tests.
Weighing in on climate risks publicly is new territory for the Fed. Officials spent years tiptoeing around the topic, which is politically charged in the United States. The central bank only fully joined a global coalition dedicated to research on girding the financial system against climate risk late last year. The possibility of climate-tied stress tests has been especially contentious, and has recently drawn criticism from Republican lawmakers.
“We have seen banks make politically motivated and public relations-focused decisions to limit credit availability to these industries,” more than 40 House Republican lawmakers said in a December letter, specifically referring to coal, oil and gas. They added that “climate change stress tests could perpetuate this trend, allowing regulated banks to cite negative impacts on their supervisory tests as an excuse to defund or divest from these crucial industries.”
Jerome H. Powell, the Fed chair, and Randal K. Quarles, the vice chair for supervision — both named to their jobs by President Donald J. Trump — suggested in response that the Fed was in the early stages of researching its role in climate oversight.
“We would note that it has long been the policy of the Federal Reserve to not dictate to banks what lawful industries they can and cannot serve, as those business decisions should be made solely by each institution,” they wrote last month.
Mr. Powell and Mr. Quarles echoed the lawmakers’ assertion that the Fed’s bank stress tests measured bank capital needs over a much shorter time frame than climate change, though they said the Fed was working to help banks manage their risks, including those related to climate.
The central bank is quickly moving toward greater activism on the topic. Its Supervision Climate Committee, announced last month, will work “to develop an appropriate program” to supervise banks’s climate-related risks, Ms. Brainard said Thursday. The Fed is also co-chair of a task force on climate-related financial risks at the Basel Committee on Banking Supervision, a global regulatory group.
Though the central bank is politically independent, President Biden has placed climate at the center of his administration’s economic priorities. Treasury Secretary Janet L. Yellen has pledged to “fight the climate crisis.”
Ms. Brainard, the Fed’s last remaining governor appointed solely by President Barack Obama, has been a leading voice in pushing for greater attention to climate issues, speaking on the matter at a conference in 2019. So has Mary C. Daly, president of the Federal Reserve Bank of San Francisco, who held that conference. (Mr. Powell was initially appointed by Mr. Obama, but then elevated to chair under Mr. Trump.)
“It is a fact that severe weather events are increasing,” Ms. Daly said during a webcast event this week, noting that “half the country is in a winter storm, and then in the summer they’ll be in a heat wave.”
She said the Fed needed to figure out how to deal with potentially disruptive risks as they emerged given that it is responsible for the nation’s economic health, works with other regulators to protect the safety of the financial system and is the steward of the payments system — the guts of the financial system in which money is transferred and checks are processed.
“We have to understand what the risks are, and think about how those risks can be mitigated,” Ms. Daly said. “Our responsibility is to look forward, and ask not just what is happening today, but what are the risks.”