Fed Publishes Pilot Climate Scenario Analysis for Banks

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    Stockholm (NordSIP) – As the integration of climate change concerns continues to gain momentum since 2015, central banks are one of the most important yet slow sectors to embrace this trend. While the ECB has been keen to embrace climate action since Christine Lagarde took over its leadership, things have moved slower across the pond.

    Nevertheless, progress is happening. At the end of January the Board of the Federal Reserve announced it would be conducting a pilot Climate Scenario Analysis (CSA) exercise. The purpose is to learn about large banking organisations’ climate risk-management practices and challenges and to enhance their ability and that of supervisors to identify, measure, monitor, and manage climate-related financial risks.

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    The Pilot CSA Exercise

    This pilot CSA exercise will gather qualitative and quantitative information about the climate risk-management practices of large banking organisations to ensure that supervised institutions are appropriately managing all material risks, including financial risks related to climate change.

    “Climate scenario analysis—in which the resilience of financial institutions is reviewed under different climate scenarios—is an emerging risk-management and supervisory tool used to evaluate climate-related financial risks. By considering a range of possible future climate pathways and associated economic and financial developments, scenario analysis can help large banking organisations and supervisors understand climate-related financial risks,” the Fed adds in its preface to the CSA instructions.

    The CSA exercise will collect and discuss detailed documentation of governance and risk-management practices, measurement methodologies, data challenges and limitations, estimates of the potential impact on specific portfolios, and lessons learned from this exercise that could inform any future CSA exercises.

    Current Policy & Net Zero by 2050 Forecasts

    The Fed has also provided a data set of macroeconomic forecasts it estimated based on two main carbon emission pathways, one consistent with the present policies and another focusing on policies more consistent with net-zero emissions by 2050. Armed with these forecasts banks can begin to understand the impact of climate change and the energy transition on their businesses. Given the global presence of American financial institutions, the data set includes measures for the US economy, but also for Europe, the UK and Japan.

    “These climate scenarios are neither forecasts nor policy prescriptions and do not necessarily represent the most likely future outcomes or a comprehensive set of possible outcomes. Rather, they represent a range of plausible future outcomes that can help build understanding of how certain climate-related financial risks could manifest for large banking organisations and how these risks may differ from the past,” the Fed clarifies in the preface.

    Not Stress Tests

    Last but not least, the Fed is keen to emphasise that the CSA exercise is distinct and separate from regulatory stress tests. “The Board’s stress tests are designed to assess whether large banking organisations have enough capital to continue lending to households and businesses during a severe recession. The pilot CSA exercise, on the other hand, is exploratory in nature and does not have consequences for bank capital or supervisory implications,” the Feds preface concludes.

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