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Big banks complete climate analysis for Fed while Powell tries to avoid becoming climate policymaker

The Federal Reserve disclosed results from an assessment of how big US banks would be impacted by climate change, an exercise that created new political tensions for the central bank.

JPMorgan Chase (JPM), Bank of America (BAC), Citigroup (C), Wells Fargo (WFC), Goldman Sachs (GS), and Morgan Stanley (MS) found that 20%-50% of their commercial and residential real estate loans in the Northeast would be impacted by the most severe climate shock— defined as having no insurance coverage for a once-in-200-year event.

The impact would be a change in the estimated probability of default on those loans.

The banks were tasked with determining how heat waves, wildfires, higher average temperatures, a hurricane in the Northeast, and another hazard of their choosing would affect their loan portfolios.

FILE - Pedestrians approach JPMorgan Chase headquarters on Dec. 29, 2023, in New York. JP Morgan reports earnings on Friday, April 12, 2024. (AP Photo/Peter Morgan, File)
Pedestrians approach JPMorgan Chase headquarters in New York. (AP Photo/Peter Morgan, File) (ASSOCIATED PRESS)

But they had a difficult time modeling climate risks to assess the impact on those portfolios, noting significant challenges gathering data and measuring climate-related risks.

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The goal was for the Fed to better understand banks' risk-management approaches to this issue so it can manage the risks climate poses to the wider financial system.

The climate analysis was exploratory and did not come with any penalties for banks, unlike a separate annual stress test run by the Fed designed to determine whether banks can withstand severe economic shocks.

Yet the test itself created new political complications for the central bank and Chairman Jay Powell, who has gone out of his way in public speeches to make it clear the Fed would avoid making climate policy.

"Policies to address climate change are the business of elected officials and those agencies that they have charged with this responsibility," he said during a speech last month at Stanford University. "The Fed has received no such charge."

STANFORD, CALIFORNIA - APRIL 03: Federal Reserve Bank Chair Jerome Powell speaks during the Stanford Business, Government and Society Forum at Stanford University on April 03, 2024 in Stanford, California. Powell spoke at the Stanford’s first Business, Government, and Society Forum with the  theme of  responsible leadership in a polarized world. (Photo by Justin Sullivan/Getty Images)
Federal Reserve Bank Chair Jerome Powell speaks at Stanford University last month. (Justin Sullivan/Getty Images) (Justin Sullivan via Getty Images)

"We are not, nor do we seek to be, climate policymakers," he said during his speech, pledging to avoid "mission creep."

That hasn’t stopped lawmakers and other policymakers from criticizing Powell on this subject.

His remarks on climate came roughly two weeks after Senators Elizabeth Warren and Sheldon Whitehouse sent a letter to Powell arguing the Fed’s high interest rates were delaying clean energy developments.

Sen. Whitehouse told Yahoo Finance last month that other central banks around the world closely consider climate change because "if left unchecked climate change will pose 'systemic risks' to our financial system and the broader economy."

And Republicans have also repeatedly come down on Powell for considering rules that would test banks' ability to withstand climate-related scenarios, arguing it falls out of the scope of the Fed's authority.

Not everyone within the Fed agrees with the approach, either.

Last May, Fed Governor Chris Waller said he doesn’t believe climate change poses a serious risk to the US financial system even as the central bank tested the resilience of banks under different climate scenarios.

WASHINGTON, DC - FEBRUARY 13: Christopher Waller testifies before the Senate Banking, Housing and Urban Affairs Committee during a hearing on their nomination to be member-designate on the Federal Reserve Board of Governors on February 13, 2020 in Washington, DC. (Photo by Sarah Silbiger/Getty Images)
Fed governor Christopher Waller. (Sarah Silbiger/Getty Images) (Sarah Silbiger via Getty Images)

"Climate change is real, but I do not believe it poses a serious risk to the safety and soundness of large banks or the financial stability of the United States," Waller said in a speech in Madrid, Spain.

"I don't see a need for special treatment for climate-related risks in our financial stability monitoring and policies," he added.

But Powell maintains that the central bank has a narrow role that relates to supervising banks.

"The public will expect that the institutions we regulate and supervise will understand and be able to manage the material risks that they face, which, over time, are likely to include climate-related financial risks," Powell said on April 3.

"We will remain alert to the risk that there will be pressure to expand that role over time."

Banks used different approaches to develop the physical and transition risk scenarios required by the Fed and to translate these scenarios into climate-adjusted credit risk parameters.

They also noted the need to monitor changes across the insurance industry, including changes in insurance costs over time and the impacts of those changes on consumers and businesses in specific markets and segments.

Banks' estimates of climate-adjusted credit risk parameters, such as probability of default, showed significant differences in impact across sectors, regions, and counterparties.

The exercise was exploratory in nature and does not have capital consequences.

Drawing on lessons learned from the exercise, the Fed said it will continue to engage with participating banks regarding their capacity to measure and manage climate-related financial risks.

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