Federal Reserve Governor Brainard Anticipates Supervisory Guidance as Banks Manage Climate Risks
October 12, 2021
On October 7, Federal Reserve Governor Lael Brainard gave a speech at the 2021 Federal Reserve Stress Testing Research Conference where she shared that the Fed is developing scenario analysis to “model the possible financial risks associated with climate change and assess the resilience of individual financial institutions and the financial system to these risks.” She noted the importance of modeling both the transition risks arising from changes in policies, technology, and consumer and investor behavior and the physical risks of climate-related damages.
In her remarks, Brainard outlined several key considerations related to scenario analysis:
- Learning from other countries – a group of regulators from across the world has been sharing best practices regarding climate-related risk management within the Network of Central Banks and Supervisors for Greening the Financial System (NGFS), which the Fed joined last year.
- Overcoming implementation challenges such as the absence of historical precedents and the need to consider interdependencies across the financial system (e.g., resilience of insurance and other hedging strategies).
- While incorporating the effects of policy changes in the modeling of transition risks is currently possible, the “building blocks for assessing the economic consequences of physical risks in the presence of substantial uncertainty are still in development.”
- Appreciating that the consequences of climate change will vary by region and economic sector.
- Eliminating critical data gaps. Brainard noted the important role the Securities and Exchange Commission (SEC) must play in ensuring consistent, comparable, and, ultimately, mandatory data and disclosures across the financial system. (See our article for more detail on the SEC’s work in this regard.)
Brainard closed her remarks by stating that both the prudential (Federal Reserve’s Supervision Climate Committee) and macroprudential (Federal Reserve’s Financial Stability Climate Committee) work programs will benefit from the development of climate scenario analysis.