The Federal Reserve’s [1] Pilot Climate Scenario Analysis Exercise [2] is meant to put measurements and metrics in place in order to understand the financial community’s exposure to climate change, and the time is growing near for the first crop of data to make its debut as Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, and Wells Fargo must submit their reports by July 31.
This is the first time that climate scenario analysis and market-recognized metrics have been combined; it is also the first time that banks are being asked to report on climate risk exposure in this way.
According to CoreLogic [3], banks have long had portfolios of property data but have not systematically aggregated them to assess future climate risk questions. CoreLogic has been using climate risk software to help businesses and regulators understand their exposure to nature, as well as address questions about risk factors and how to measure impacts against a property portfolio.
According to CoreLogic, the evaluation takes the following measures in order to report on two types of risk: the first is transition risks associated with the commercial, government, and consumer responses to climate change within their commercial and real estate portfolios. The second is the physical risks posed to these portfolios.
The physical risk analysis examines two potential perils based on the year 2050:
- The impact of a severe hurricane in the Northeastern United States
- The impact of a severe natural disaster in a geographical location of the banks’ choosing
The banks then project losses for each of these scenarios:
- A 100-year return loss event (with a 1% probability of the peril occurring)
- A 200-year return loss event, with insurance (with a 0.5% probability of the peril occurring)
- A 200-year return loss event without insurance (with a 0.5% probability of the peril occurring)
The probabilities of these events occurring are small but potentially devastating. The analysis of property risk in the face of climate change will cover a one-year period and include projected climate changes such as extreme heat, heavy precipitation and drought. The banks will submit their findings by July 31, 2023.
So why is the Fed assessing property risk now? The Fed hopes to use this exercise to begin developing an early warning reporting system for climate change, the Fed is looking to define meaningful and measurable metrics to track lenders and their portfolios. The intent is then to share and articulate these metrics so investors can understand what is happening in real time.
By calling this pilot a “learning exercise,” the Fed’s intent is to learn if the banks have the resources, the processes and the knowledge base to complete these reports for two separate perils, under three different scenarios and in two different geographic areas. When the Fed reports on these outcomes later this year, findings will be anonymized, providing industry-wide results on climate risk scores. This will be a benchmark in the marketplace when we learn what information the banks can report and discover how to leverage that data.
Click here [4] to view the report in its entirety.