The Federal Reserve Board and six large American banks released the results of a pilot climate scenario analysis that explored how resilient the banks’ business models were to climate-related financial risks.
The analysis, released Thursday, was intended to help “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,” according to its executive summary.
Banks participating in the exercise included Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, and Wells Fargo.
“Most participants relied on existing credit risk models to estimate the impact of physical and transition risks on their portfolios,” the summary stated, “and assumed that historical relationships between model inputs and outputs continue to hold as the climate and the structure of the economy evolve.”
Banks were tasked with examining how physical and transition climate-related risk could affect their organizations.
“Physical risks refer to the harm to people and property arising from acute, climate-related events, such as hurricanes, wildfires, floods, heatwaves, and droughts as well as longer-term chronic phenomena, such as higher average temperatures, changes in precipitation patterns, sea level rise, and ocean acidification,” the analysis defined. “Transition risks refer to stresses to certain institutions, sectors, or regions arising from the shifts in policy, consumer and business sentiment, or technologies associated with the changes that would be part of a transition to a lower carbon economy.”
As they attempted their own climate scenario analysis, participating banks reported “significant data and modeling challenges in estimating climate-related financial risks,” the summary stated, including “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.”
Participating in the study highlighted for banks the importance of monitoring changes in insurance costs caused by physical and transitional climate-related risks over time and in specific markets and segments.
Climate-related risks are “highly uncertain and challenging to measure,” and that uncertainty made it difficult for banks to determine how to best incorporate these risks into their risk management frameworks, the summary said.
While the results of the analysis did not have capital consequences, the Fed said in a press release it would apply lessons learned “to engage with participating banks regarding their capacity to measure and manage climate-related financial risks.”
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