Board of Governors of the Federal Reserve System

While I supported seeking public comment on the climate-related guidance published by the Board in December of 2022, in my view the final guidance will create confusion about supervisory expectations and will result in increased compliance cost and burden without a commensurate improvement to the safety and soundness of financial institutions or to the financial stability of the United States.

Unclear Expectations and Unintended Consequences
Institutions of all sizes have long been expected to manage the risks associated with their activities, including climate-related financial risks. While the guidance adopts a specialized regime for climate risks, it does not explain why this unique treatment for climate risks is warranted. The guidance simply suggests that banks are "likely to be affected" by the physical and transition risks associated with climate change. In response to this likelihood of being affected, the banking agencies suggest that firms monitor and measure climate-related risks over indefinite time horizons. Banks are expected to "develop strategies, deploy resources, and build capacity to identify, measure, monitor, and control for climate-related financial risks." The guidance includes few specifics about this data collection expectation, and given the lack of specificity, it is likely that the expected scope of the data collection will increase over time.

The guidance also suggests banks engage in "scenario analysis," broadly defined as "exercises used to conduct a forward-looking assessment of the potential impact on a financial institution of changes in the economy, changes in the financial system, or the distribution of physical hazards resulting from climate-related financial risks." Compounding the challenge for banks applying this guidance is the uncertainty around the appropriate planning horizon. The guidance expressly notes that the planning horizon a bank should use may extend "beyond the financial institution's typical strategic planning horizon."

The benefit of requiring banks to plan for events that occur far into the future seems limited, as long-dated predictions about the future are likely to be highly speculative and heavily influenced by the underlying assumptions, and therefore of limited or no utility to the bank in managing risk. This approach is a significant departure from existing supervisory standards, like the Comprehensive Capital Analysis and Review exercise, which implements a two-year planning horizon; the Liquidity Coverage Ratio, with a 30-day planning horizon, and the Net Stable Funding Ratio, with a one-year planning horizon. The guidance provides no explanation for this deviation from normal supervisory time horizons.

The new climate-related expectations established by this guidance could have a significant impact on banks. The costs to implement new data collections will be substantial not only to institutions attempting to comply with uncertain elements of the guidance, but also to bank customers that will be asked to provide more information when seeking credit or other banking products. One likely potential consequence could be to discourage banks from lending and providing financial services to certain industries, forcing them to seek credit outside of the banking system from non-bank lenders. This could result in decreasing or eliminating access to financial services and increasing the cost of credit to these industries. These costs will ultimately be borne by consumers.

The lessons learned from supervisory failures during the bank stress in the spring clearly illustrate that bank examiners and bank management should focus on core issues, like credit risk, interest rate risk, and liquidity risk. Today's guidance could ultimately distract attention and resources from these core risks.

Impact on Low and Moderate Income Communities
This guidance notes that climate change, and the actions taken by banks to manage climate risk, could have unintended consequences for low and moderate-income ("LMI") communities, including increasing the cost of credit, or reducing credit availability in those communities. This is an important concern.

Consumers and businesses in LMI communities often have fewer options for obtaining credit and banking services, and I am concerned that today's guidance could exacerbate this problem. The guidance notes that a bank's board should "consider the impact that the financial institution's strategies to mitigate climate-related financial risks could have on LMI and other underserved communities and their access to financial products and services, consistent with the financial institution's obligations under applicable consumer protection laws." However, it is not clear how the agencies expect consumer protection laws—laws that already apply to lending activities in these areas—will mitigate the potential harm caused by banks' climate risk mitigation strategies.

In my view, banks thinking about this guidance—and supervisory staff considering this guidance in the course of examination work—must be mindful of the legal obligations under the Community Reinvestment Act ("CRA") to help meet the credit needs of the communities in which banks do business, especially in LMI communities. I do not believe it would be appropriate to criticize banks for prudent lending activities in LMI communities.

Scope
Consistent with the original proposal, the final climate guidance is limited to large firms, those above $100 billion in assets. However, I am concerned that there will be pressure on examiners to apply these expectations to smaller banks because the guidance suggests that all financial institutions, regardless of size, may have material exposure to climate-related financial risks. I continue to believe that the exclusion of smaller firms is appropriate based not only on the size, risk, and business model of these firms, but also in light of the robust risk management expectations already applicable to these firms.

Conclusion
Climate change is an important public policy issue in the United States and globally. However, the Federal Reserve has limited, narrowly focused mandates and responsibilities that are established by statute. These mandates and responsibilities do not extend to climate policymaking.¹ While this guidance nominally focuses on climate-related "financial risks," I am concerned that the guidance could be used by the Federal Reserve and other federal banking agencies to pursue climate policies leveraging the opacity of the supervisory process.

At a time when confidence in public institutions is waning, the Federal Reserve should strive to demonstrate beyond doubt that it executes its duties in an independent manner, focusing on its statutory obligations.

For all of these reasons, I cannot support the Board's approval of this guidance.

1. While today's guidance comes on the heels of Treasury Department pronouncements about net-zero financing and investment, the banking agencies' climate guidance is silent about "net-zero" commitments. See U.S. Department of the Treasury, Principles for Net-Zero Financing & Investment (PDF) (September 2023). Return to text