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Feds Prep Large Financial Institutions to Brace for Climate-Related Risk

The saying goes, “Proper preparation prevents poor performance.” And as the “Five P’s” may be applicable to many instances in life, the governing bodies of several federal agencies have banded together to provide an outline for the nation’s large financial institutions to abide by as climate-change continues to evolve.

The Office of the Comptroller of the Currency (OCC), Board of Governors of the Federal Reserve System; and Federal Deposit Insurance Corporation (FDIC) have jointly finalized principles that provide a high-level framework for the safe and sound management of exposures to climate-related financial risks for large financial institutions.

The principles outlined are consistent with the risk management framework described in the agencies’ existing rules and guidance. The principles are intended for financial institutions with $100 billion or more in total assets, and address physical and transition risks associated with climate change.

In December 2021, April 2022, and December 2022, the OCC, FDIC, and Federal Reserve Board proposed substantively similar guidance on risk management principles to support the effective management of climate-related financial risks.

“The principles do not tell bankers what customers or businesses they may or may not bank. Rather, they clarify how large banks can maintain effective risk management and keep their balance sheets sound and continue to be a source of strength to their customers and communities through a range of scenarios,” said Acting Comptroller of the Currency Michael J. Hsu. “One challenge with emerging risks is that before these risks fully manifest themselves, such as through a bank failure or a full-blown financial crisis, this absence of significant harm can lead to complacency.”

The principles are intended to support efforts by large financial institutions to focus on key aspects of climate-related financial risk management. General climate-related financial risk management principles are provided with respect to a financial institution’s governance; policies, procedures, and limits; strategic planning; risk management; data, risk measurement, and reporting; and scenario analysis. Additionally, the principles describe how climate-related financial risks can be addressed in the management of traditional risk areas, including credit, market, liquidity, operational, and legal risks.

“The Federal Reserve has narrow, but important, responsibilities regarding climate-related financial risks, which are tightly linked to our responsibilities for bank supervision. Banks need to understand, and appropriately manage, their material risks, including the financial risks of climate change. The guidance issued today is squarely focused on prudent and appropriate risk management. I am therefore able to support its issuance,” said Jerome H. Powell, Chair of the Board of Governors of the Federal Reserve System. “It is also important to continue to be clear on what we are not doing. The Federal Reserve is not and will not be a ‘climate policymaker.’ Decisions about policies to address climate change must be made by the elected branches of government. Over time, we must be vigilant to avoid crossing or blurring that line. It is not the Fed's role to tell banks which businesses they can and cannot lend to, and this guidance is not intended to do so. The guidance clearly articulates this fundamental principle—an important addition to the proposal.”

The principles drafted by the OCC, FDIC, and Federal Reserve neither prohibit nor discourage large financial institutions from providing banking services to customers of any specific class or type, as permitted by law or regulation. The decision regarding whether to make a loan or to open, close, or maintain an account rests with the financial institution, so long as the financial institution complies with applicable laws and regulations.

The final guidance contains high-level principles covering six areas:

  • Governance
  • Policies, procedures, and limits
  • Strategic planning
  • Risk management
  • Data, risk measurement
  • Reporting and scenario analysis

Additionally, the final principles describe how climate-related financial risks can be addressed in the management of traditional risk areas.

The goal of these final principles is intended to promote a consistent understanding of the effective management of climate-related financial risks.

CoreLogic estimates that insured losses across southeastern U.S. due to Hurricane Idalia stood at less than $2 billion, encompassing insured losses to residential and commercial properties from wind and storm surge flooding. Storm surge losses do not include impacts to the National Flood Insurance Program (NFIP).

“The guidance states that banks should be attentive to the impact of climate risk management efforts on low-and- moderate-income and other underserved consumers and communities,” said Michael S. Barr, Vice Chair for Supervision, Board of Governors of the Federal Reserve System. “Banks should ensure that vulnerable communities are not inadvertently harmed by their efforts to mitigate climate-related financial risks.”

About Author: Eric C. Peck

Eric C. Peck has 20-plus years’ experience covering the mortgage industry, he most recently served as Editor-in-Chief for The Mortgage Press and National Mortgage Professional Magazine. Peck graduated from the New York Institute of Technology where he received his B.A. in Communication Arts/Media. After graduating, he began his professional career with Videography Magazine before landing in the mortgage space. Peck has edited three published books and has served as Copy Editor for Entrepreneur.com.

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