Climate Stress Test Proposed to Test Bank Vulnerability

EDITOR NOTE: The New York Federal Reserve Bank has developed a “climate stress test” to measure the risks of climate change for U.S. banks. The tests measure whether banks have enough cash on hand to deal with climate-related issues, but not everyone is thrilled with this type of monitoring. According to Yahoo! Finance, the tests have “drawn intense criticism from U.S. Republican lawmakers who say that monitoring for such risk goes beyond the central bank's remit.” These tests give a higher risk score to banks that deal with companies in industries that are deemed enemies of climate change, such as fossil fuel firms. This test goes hand-in-hand with “U.S. banking regulators, including the Fed, are already moving toward requiring more disclosure of how climate-related risks could affect the value of banks' assets.”

Sept 24 (Reuters) - Researchers at the New York Federal Reserve Bank have developed an approach to measuring banks' exposures to climate-related risks, a possible early step toward assessing whether financial institutions have enough capital on hand to withstand them. 

  The publication Friday of a paper describing the new methodology may mark an early step toward an eventual "climate stress test" for U.S. banks. It's an approach already used by other global central banks but that has drawn intense criticism from U.S. Republican lawmakers who say that monitoring for such risk goes beyond the central bank's remit. 

  Fed Chair Jerome Powell for his part has said he believes that making sure banks are resilient to the threat of climate change is squarely within the Fed's mandate. 

  Friday's paper, titled simply "Climate Stress Testing," outlines for the first time exactly how the Fed could go about checking the vulnerability of banks and the financial system broadly to shocks as the nation moves to limit emissions of heat-trapping carbon dioxide. 

  "Banks that provide financing to fossil fuel firms are expected to suffer when the default risk of their loan portfolios increases, as economies transition into a lower-carbon environment," the researchers said. "If banks systemically suffer substantial losses following an abrupt rise in the physical risks or transition risks, climate change poses a considerable risk to the financial system." 

  The researchers developed a metric for assessing climate risk, and found that for some banks with big fossil fuel exposures it was "economically substantial." 

  Using Citigroup as an example, the researchers said the expected amount of capital that the bank would have needed to raise under the climate stress scenario to restore a prudential capital ratio increased by $73 billion in 2020, at a time when oil prices were falling as the pandemic reduced energy demand. 

Originally posted on Yahoo! Finance