US block on Basel risks derailing global measures on climate risk

June 27, 2024|Written by |Basel Committee on Banking Supervision, Federal Reserve
Close-up of the US flag
The US is accused of attempting to water down attempts by the Basel Committee to address climate-related financial risks. © Samuel Branch

It has been a little more than three years since President Joe Biden issued his executive order on climate-related financial risk. Since then, there has been some limited progress made by US institutions on addressing the financial risks posed by an increasingly disruptive climate.

The inter-agency Financial Stability Oversight Council (FSOC) issued a report recognising that both the physical and transition components of climate are emerging risks to financial stability. The banking agencies have issued guidance to financial institutions to manage the financial risks of climate change. And the Treasury Department, where I worked for three years until earlier this year, has released principles to guide financial institutions’ net-zero financing commitments, as well as reports on climate-related regulation and supervision of the insurance industry and the implications of climate change for household finances.

These steps, while positive, are mostly discretionary and the US remains at the back of the pack among its G20 colleagues in addressing the financial implications of climate change. This puts US financial regulators out of step with the international consensus on the risks that climate change poses to the financial system. Their efforts, or lack thereof, also run counter to the Biden administration’s own climate finance agenda.

There has been a narrative among some US politicians that the Basel Committee for Bank Supervision (BCBS), the multilateral body formed to coordinate international rules governing the banking system, is a place where European officials lead their US counterparts around by the nose. In reality, the US played an instrumental role in establishing the original Basel capital accords after US banks invested in too much risky sovereign debt.

Since then, the US has often played a leading role in setting minimum but non-binding global standards for financial regulation and then implemented those agreements consistent with US law. This was particularly true after the global financial crisis of 2007-09.

In testimony given to the Senate banking committee in 2013, then-Federal Reserve chair Ben Bernanke noted that the US occupies a “leadership position” at the BCBS. “[O]ther countries may or may not follow,” he continued. “But whether they do or not… we should do whatever we need to do to make sure that the US financial system is safe.”

US delaying tactics

The contrast with today – when the US has gone from leaders to laggards in both standard-setting and implementation – is striking. The banking agencies are struggling to implement the final stages of the Basel 3 international capital accord, known as the Basel endgame. US banking regulators, and the Fed in particular, are also reportedly blocking important actions at the BCBS to address the financial risks posed by climate change.

Specifically, they are seeking to: make climate transition plan guidelines and key disclosure standards for banks optional, not mandatory; remove financed emissions from the proposed disclosure framework; halt work on monitoring implementation of the BCBS principles for effective management and supervision of climate-related financial risks; and prevent the incorporation of climate risks into binding capital requirements.

For the BCBS to concede to these demands would undermine efforts that are foundational in establishing a meaningful framework for quantifying climate-related financial risks and disclosing them to the markets. They would also prevent that climate risk framework from translating into binding prudential regulations when implemented by member jurisdictions. In addition to being a substantive disaster, the mere fact that these normally behind-the-scenes negotiations have spilled out into the open is an indicator of how much the US’s obstruction has frustrated its foreign counterparts.

Who can blame the Europeans for their frustration? Two of the US banking agencies – the Office of the Comptroller of the Currency and Federal Deposit Insurance Corporation – have identified climate risk as a priority but the agencies’ most meaningful measure to date, the joint guidance on climate-related financial risk management, is purposefully “high-level” and “flexible” and fails to incorporate transition plans as a tool for managing financial institutions’ transition risk.

Deeply flawed climate scenario analysis

Fed chair Jerome Powell has acknowledged that climate risks implicate its bank supervision and financial stability responsibilities, but the Fed has not consistently recognised it as an area of focus. The lackluster results of the Fed’s pilot climate scenario analysis exercise, which analysed the physical and transition exposures of the six largest US banks, demonstrate how much work the US still has to do just to understand the scope of the problem and ensure that banks have basic risk management frameworks in place.

The physical risk scenarios do not reflect what we know about the possibility for disorderly outcomes when ecosystems breach tipping points based on global warming trends. The in-scope banks were allowed to rely on historical trends on the structures of the climate and the economy, rather than forward-looking projections – there is no precedent in human history for the planetary shifts projected by the IPCC and others, so backwards-looking data is useless.

The banks also lack comprehensive and consistent data related to factors like availability of insurance coverage – which is already becoming less available and affordable across the US – and their counterparties’ plans to manage their own climate-related risks. Finally, while some of the credit loss predictions appear to be quite low relative to the size of the banks’ assets, the Fed conceded that there is a high degree of uncertainty inherent in estimating climate risk. Members of Congress have taken notice of the lack of progress and they are not happy.

Meanwhile, the EU has maintained the courage of its convictions. It has not only adopted microprudential supervisory guidance to reduce risks that large banks are facing, as the US has done, but also taken steps to reduce risks to other financial entities and financial stability.

Measures in the EU include increasing disclosure, enhancing due diligence and increasing attention to macroprudential strategies to reduce climate risk. All signs suggest that European regulators are close to issuing climate-related prudential standards and fining firms for non-compliance with climate risk standards.

Net zero falls within agency mandates

Beyond these specific policies, there is a more fundamental issue for the US’s approach to climate-related financial risk. One of the arguments against more aggressive climate action is that it lies outside the agencies’ legal mandates, and that the agencies should “stick to [their] knitting” and not be “climate policymakers”. But there is a clear consensus, memorialised in the FSOC’s climate threat report, that climate change presents financial risks that regulatory agencies have a responsibility to address.

The banking agencies’ failure to address these risks is not just inconsistent with their legal mandates. It also runs counter to the president’s climate risk executive order and the Biden administration’s broader goals of driving clean energy investments, through the Inflation Reduction Act and other channels, to achieve net zero by 2050.

It’s difficult to see this departure from the international consensus as anything other than capitulation to domestic political interests. If the US fails to get its act together, the best case scenario is that it will continue to lag its international counterparts in addressing what Treasury secretary Janet Yellen has described as “an existential threat” that “poses a tremendous risk to our country’s financial stability”.

Worse still, the lack of US action could delay other jurisdictions, as it has with the final Basel endgame rules, where slow-walking has led Europe to delay implementation of its own rules by a year.

This should be a wake-up call for the US to stop obstructing the countries that are leading the way in our absence and reclaim a position of global leadership. Because as US banking agencies fiddle, the planet continues to burn.

This page was last updated June 27, 2024

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