Summary and Background of Climate-related Financial Risk Management for Large Financial Institutions

Summary

The FDIC is proposing that large financial institutions, defined as those with over $100 billion in total consolidated assets, be subject to a climate-related financial risk management framework.

The FDIC has concluded the effects of climate change and the transition to a low carbon economy present emerging economic and financial risks that threaten the safety and soundness of financial institutions and the stability of the financial system. In particular, the FDIC believes financial institutions are likely to be affected by physical risks (e.g., harm to people and property arising from climate events such as hurricanes, wildfires, droughts, and changes in sea levels) and transition risks (e.g., financial stress caused by a transition to a low-carbon economy.)

To manage climate-related financial risks, the FDIC has proposed a framework that would require large banks to ensure climate-related financial risks are addressed in the bank’s (1) governance; (2) policies, procedures and limits; (3) risk management; and (4) data, risk measurement, and reporting. Additionally, the FDIC would require large banks to address climate-related financial risk in the following risk areas: (1) credit risk; (2) liquidity risk; (3) interest rate risk; (4) operational risk; (5) strategic planning; (6) reputational risk; (7) liability or litigation risk.

Finally, the proposal would require large banks to perform scenario analysis, which is a modeling exercise used to conduct a forward-looking assessment of the potential impact on a bank due to changes in the economy, financial system, or physical hazards due to climate-related events.

Scenario analysis explores the impacts of climate-related risks on the institution’s strategy and business model, identifies and measures vulnerability to relevant climate-related risk factors including physical and transition risks, and estimates climate-related exposures and potential losses across a range of scenarios.

Current Risk Management Practices

Explain why you believe a separate risk-management framework for climate-related financial risk is unnecessary to manage safety and soundness at your bank or any community bank with fewer than $100 billion in assets.

Rationale for Position

  • Existing risk management practices are effective and have enabled community banks to manage climate-related risk for decades.

  • Unlike large banks, community banks do not pose systemic risk to the financial system and should not ever be subject to a “one-size-fits-all” climate-related financial risk management framework designed for large, complex institutions.

  • Compliance with a climate-related financial risk management framework would be expensive and would unnecessarily duplicate current risk management practices.

Points to Raise

  • Explain why you do not believe climate-related financial risks threaten the safety and soundness of your institution.

  • Explain how your bank currently applies risk management practices to manage climate-related risks.

  • If your bank has experienced a severe weather event, explain how your bank prepared for the event, recovered from the event, and how your bank served the community in the aftermath of the event.

  • Explain that with the adoption of CECL, your bank will need to be even more concerned about reflecting future risks, such as the risk that the climate will change, in loan loss reserves.

  • Articulate your concerns about the costs of the proposal.

Scenario Analysis

Scenario analysis is an expensive exercise that requires specialized third-party expertise, and it should not be mandatory for community banks, given the small size, relative non-complexity and lower risk profile of community banks as compared to large banks.

Rationale for Position

  • Scenario analysis is a complex, data-driven modeling exercise that would require community banks to hire specialized third-party consultants to perform the work.

  • To conduct scenario analysis for transition risks, community banks would need to gather climate data (such as greenhouse gas emissions data) from their customers, many of which do not maintain this data and would object to gathering and disclosing this data.

  • Scenario analysis would require community banks to forecast for remote and speculative risks and be of little practical utility to community banks that are already familiar with their concentration risks and how to manage these risks.

Points to Raise

  • Share your concerns about the cost for scenario analysis.

  • Describe the difficulties your bank may face in hiring qualified experts to perform scenario analysis, particularly if your bank had to compete with large banks to secure these services, as there are few individuals located in your community who are currently qualified to perform this work.

  • Share your concerns about gathering climate data from your customers.

  • Describe the practices your bank already implements which eliminate a need for performing scenario analysis. For example, stress testing the loan portfolio as part of transitioning to CECL, or participating in FEMA’s National Exercise Program or the Homeland Security Exercise and Evaluation Program.

When you have finished drafting your letter, copy and paste it into ICBA’s Grassroots Center, where it will be sent directly to the FDIC.

Comments are due by June 3, 2022