Looking Over the Horizon

This paper by the Roosevelt Institute and Public Citizen argues that safety and soundness supervision is a mechanism that can be deployed quickly and flexibly to guard against emerging financial risks posed by climate change.

Although both of the organisations behind the paper have previously advocated the proactive use of regulatory interventions such as climate-adjusted capital requirements, the authors say supervision has significant advantages as a means of effecting action without the delays and political compromises inherent in rulemaking and legislation.

The report argues that supervisors can update their expectations to deal with the unique characteristics of climate risk – in particular the fact that when banks finance emissions today, they contribute to risks the banking system will face from climate change in the future. It recommends a precautionary approach to address risks now, even if banks’ projections suggest loans will mature before the risks materialise.

The paper also considers how banks can balance risk management with maintaining the flow of credit to communities harmed by climate change, noting that low-income communities and communities of colour already lack the necessary resources for investments in climate adaptation and resilience.

The authors argue that regulators have experience of addressing other novel risks that banks have faced, such as the underwriting of oil and gas exploration loans, the transition away from the use of the London Interbank Offered Rate benchmark in setting contractual interest rates, and leveraged lending after the financial crisis. The paper considers in detail the lessons that can be learned from each of these topics.

Finally, the report provides recommendations for how agencies including the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, and the Federal Reserve, should proceed in establishing clear expectations for banks. It recommends that the regulators include climate risks in their routine examinations of banks as soon as possible, and follow the European Central Bank’s example in publishing their insights from the exercise.