Executive Summary
The Federal Reserve conducted a pilot climate scenario analysis (CSA) exercise in 2023 to learn about large banking organizations' climate risk-management practices and challenges and to enhance the ability of large banking organizations and supervisors to identify, estimate, monitor, and manage climate-related financial risks. The exercise was conducted with six large bank holding companies: Bank of America Corporation; Citigroup Inc; The Goldman Sachs Group, Inc.; JPMorgan Chase & Co.; Morgan Stanley; and Wells Fargo & Company (together, "participants"). The pilot CSA exercise was exploratory in nature and does not have consequences for bank capital or supervisory implications.
The Federal Reserve neither prohibits nor discourages financial institutions from providing banking services to customers of any specific class or type, as permitted by law or regulation. The decision regarding whether to make a loan or to open, close, or maintain an account rests with the financial institution, so long as the financial institution complies with applicable laws and regulations.
The pilot CSA exercise provided the following insights:
- Participants used climate scenario analysis to consider the resiliency of their business models to a range of climate scenarios and to explore potential vulnerabilities across short- and longer-term time horizons.
- Participants took different approaches to construct the detailed physical and transition risk scenarios used in the pilot CSA exercise and to translate those scenarios into estimates of climate-adjusted credit risk parameters. Differences in approach were driven largely by participants' business models, views on risk, access to data, and prior participation in climate scenario analysis exercises in foreign jurisdictions.
- Most participants relied on existing credit risk models to estimate the impact of physical and transition risks on their portfolios and assumed that historical relationships between model inputs and outputs continue to hold as the climate and the structure of the economy evolve.
- Participants reported significant data and modeling challenges in estimating climate-related financial risks. For example, participants noted a lack of comprehensive and consistent data related to building characteristics, insurance coverage, and counterparties' plans to manage climate-related risks. In many cases, participants relied on external vendors to fill data and modeling gaps.
- Participants reported that better understanding and monitoring of indirect impacts (e.g., disruptions to local economies) and chronic risks (e.g., sea level rise) are important for managing climate-related financial risks.
- Participants highlighted the important role that insurance plays in mitigating the risks of climate change for consumers, businesses, and banks. They 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.
- Participants identified key design choices that meaningfully impacted the insights drawn from the exercise. These included choices related to the scope of the shocks, scenario severity, the starting point of the exercise, insurance assumptions, and balance sheet assumptions.
- Participants suggested that climate-related risks are highly uncertain and challenging to measure. The uncertainty around the timing and magnitude of climate-related risks made it difficult for participants to determine how best to incorporate these risks into their risk-management frameworks on a business-as-usual basis.
- While not the focus of the pilot CSA exercise, participants' estimates of climate-adjusted credit risk parameters, such as probability of default (PD), showed significant heterogeneity in impact across sectors, regions, and counterparties.1
The report includes the following sections:
- Overview of the Pilot CSA Exercise, which discusses the transmission channels through which climate-related risk drivers could impact large banking organizations and describes the overall design of the pilot CSA exercise.
- Pilot CSA Exercise Insights, which summarizes key takeaways from the exercise related to participants' climate-related financial risk-management practices, exposures to climate-related risks, and lessons learned.
- Physical Risk Module, which looks in detail at participants' approaches to physical risk scenario design, measurement methodologies, and estimates.
- Transition Risk Module, which looks in detail at participants' approaches to transition risk scenario design, measurement methodologies, and estimates.
- Governance and Risk Management, which discusses participants' governance and risk-management processes.
- Appendix, which provides notes on calculation methodologies.
References
1. The Federal Reserve did not independently estimate the impact on risk parameters. All reported results are based on estimates provided by participants. Return to text