Six of the country’s largest banks participated in a study
conducted by the Federal Reserve last year to assess the resiliency of the
banks’ business models when faced with climate-related financial risks. The
participants were Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase,
Morgan Stanley and Wells Fargo.
The agency released a report summarizing its exploratory
pilot Climate Scenario Analysis (CSA) exercise with insights about various
approaches participants used to tackle detailed physical and transition risk
scenarios. These approaches were intended to reflect differences in business
models, risk perspectives and data analysis practices against prior experience
with climate scenario exercises, according to the Fed.
“Each module described forward-looking risk scenarios,
including core climate, economic, and financial variables, where appropriate,” the
report stated. “The scenarios selected for the pilot CSA exercise were neither
forecasts nor policy prescriptions. They did not necessarily represent the most
likely future outcomes or a comprehensive set of possible outcomes. Rather,
they were chosen to represent a range of plausible future outcomes that could
help build understanding of how certain climate-related financial risks could
manifest for large banking organizations and how these risks may differ from
the past.”
Most of the banks estimated the climate-risk impact to their
portfolios using existing credit risk models, assuming historical relationships
would continue to apply despite climate and economic changes. The main
obstacles to calculating these estimates included inadequate and inconsistent
data on building characteristics, insurance coverage and counterparties’ risk
management plans. The report indicated uncertainty
about the types of climate-related risks institutions might face also presents
challenges to incorporating them into routine risk management frameworks.
“The degree of uncertainty around the timing and magnitude
of climate-related risks is high, making it difficult for participants to
determine how best to account for and manage these risks on a business-as-usual
basis,” the report stated. “Those uncertainties can generate considerable
variation in estimates of expected impacts, which complicates use of some
common risk management tools, such as quantitative risk limits, and strategic
decisions. The high degree of uncertainty is a significant factor in
considering how participants could use the insights gained from climate
scenario analysis going forward.”
The Fed plans to draw on lessons learned during the exercise
and continue engaging with the participating institutions about their demonstrated
capacity to measure and manage climate-related financial risks
The broader financial system faces climate-related risks
through macroeconomic and microeconomic channels associated with physical and
transition risk drivers, the Fed noted. Physical risks encompass acute climate
events and chronic phenomena. Transition risks stem from shifts in policy,
consumer sentiment and technology associated with a move towards a lower carbon
economy.