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US Federal Reserve launches climate risk pilot for 6 major banks

© Shutterstock / MDart10Post Thumbnail

Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley and Wells Fargo will be asked to explore different climate scenario impacts on parts of their businesses.

  • The initiative is intended to identify climate risks and how to manage them  – but it is not the same as a traditional bank stress tests.
  • The running of scenarios signals the Fed’s growing concern about the systemic economic effects of climate risk.  
  • While the climate debate is increasingly politicised in the US, this action confirms central bank unease about the implications of climate risk. 

Bank of America (NYSE:BAC), Citigroup (NYSE:C), Goldman Sachs (NYSE:GS), JPMorgan Chase (NYSE:JPM), Morgan Stanley (NYSE:MS) and Wells Fargo (NYSE:WFC) will all take part in the exercise, which will measure and manage climate-related financial risks.

Introduction of climate scenarios signals US Fed concern

This exercise is important as the challenges posed by climate change may be different from historical experience.

It will be launched in early 2023 and conclude towards the end of the year. When it starts, the central bank will publish details of the climate, economic and financial variables that will form the scenarios in the pilot.

The banks will analyse their effect on certain portfolios and strategies, which will in turn be reviewed by the Federal Reserve Board. 

The final insights to be shared with the public will not contain information specific to each bank, but will be an overview on how to identify and manage risk arising from climate change.

Phillip Basil, director of banking policy at Better Markets, a non-profit focused on the US financial system, said: “To date the Fed has woefully lagged behind many of its European counterparts in conducting climate scenario analysis, which is key to identifying, sizing, and assessing the risks that climate change poses to the financial system.

“While it is encouraging that the program will begin ‘early’ next year, the overall process must be accelerated to ensure that the banking supervisors and the American public understand the risks at the largest, too-big-to-fail banks as soon as possible. Simply having a better understanding of the risks is not enough.” 

Scenario analysis differs from capital based bank stress tests

This scenario analysis is not the same as bank stress tests, which are also designed by the Board. 

Stress tests are a method to predict whether major banks have enough capital to weather a severe recession, while climate scenarios are “exploratory in nature” and do not have “capital consequences”, according to the Fed.

The initiative may suggest that the Fed may be doubling down on its sustainability efforts amid an increasingly polarised debate over climate change.

US states push back on ESG criteria, what will they do about climate?

In August, Texas Republican Comptroller Glenn Hegar barred ten companies and 348 ESG-focused investment funds from conducting business with the state because they “boycott energy companies.” It came a year after a law prohibiting most government bodies from issuing contracts to those companies.

BlackRock, Credit Suisse and UBS were on the list, but recent analysis shows that some of those investment funds do not qualify as ESG.

Texas is not the only state concerned, with 19 Republican states having expressed concern about the use of an ESG investment lens. Nonetheless, it seems a basic facet of fiduciary duty to assess the level of risk within a corporation, a financial institution or an economy.

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