After the recent Securities and Exchange Commission’s announcement of new climate initiatives, the Federal Reserve has followed suit with its own.
The Fed has created a Supervision Climate Committee (SCC) and a Financial Stability Climate Committee (FSCC) to protect the financial sector against climate risks, said Fed Governor Lael Brainard at a Ceres 2021 conference in Boston on Tuesday.
The two committees will analyze and research how climate change may affect financial and economic institutions and activity. More specifically, the SCC’s focus is to identify and assess financial risks from climate change, as well as create resilience programs for the supervised firms, said Brainard.
Brainard noted the committee’s “microprudential work to ensure the safety and soundness of financial institutions constitutes one core pillar of the Federal Reserve’s framework for addressing the economic and financial consequences of climate change.”
The FSCC’s role will be more broad-based, focusing on the stability of the entire financial system. “So a second core pillar of our framework seeks to address the macrofinancial risks of climate change,” Brainard explained. “The committee’s role is to identify, assess and address climate risk to financial stability, which will include “complex interactions across the financial system.”
FSCC’s role will include coordination with the Financial Stability Oversight Council (FSOC) and its member agencies. It will also strive to increase the Fed’s international engagement and influence on this issue.
Microprudential work will focus on how climate risk impacts traditional financial channels such as credit, operational, market, legal, and reputational risks of individual firms. Macroprudential work will cover the impact of climate change on financial shocks and on financial system vulnerabilities that would amplify such shocks.
Brainard also pointed out that “in some respects, climate change can be seen as similar to other financial stability shocks emanating from outside the financial system, such as COVID-19, which are difficult to predict with precision and can lead to an abrupt reassessment of a broad array of economic and financial outcomes, prices, and incentives.”
But she also noted that there are differences: “Unlike episodic or transitory shocks, climate change is an ongoing, cumulative process, which is expected to produce a series of shocks. Over time, these shocks can change the statistical time-series properties of economic variables, making forecasting based on historical experience more difficult and less reliable.”
Also, the uncertainty and timing of policies during the transition period to a sustainable economy and the potential vulnerabilities in the system can pose challenges to the overall financial stability and its players.
In addition, Fed Chairman Jerome Powell recently answered climate-related questions before the House Financial Services Committee. Powell said that the Fed’s existing mandate is to supervise banks and other institutions to assure that they understand and are managing the risks that they’re running in their business.
So, while the Fed doesn’t have a ‘new’ mandate, managing those risks is what the Fed does, and “climate change is an emerging risk,” said Powell. “So, we’re looking at it carefully. We’re actually just in the very early stages of considering stress scenarios. And that’s what others are doing too.”
He said the purpose was to get a “basic understanding of how the financial system can be resilient against what may be very significant emerging risks over time.”