The Fed’s New Climate Mandate Tells Banks To Fret About Unknowable Risks

There’s no shortage of risks to keep bankers up at night: Rising interest rates, wars, commercial real estate, and a weakening Chinese economy. Yet financial regulators want banks to focus on—drum roll, please—climate change.

The Federal Reserve, Federal Deposit Insurance Corp., and Comptroller of the Currency on Tuesday published guidance directing banks on how to manage putative climate risks. [emphasis, links added]

The agencies say they aren’t dictating how banks lend to accelerate the shift to a lower-carbon economy. But reading between the lines, that’s exactly what they’re doing.

The guidance says banks must manage their balance sheets for physical risks from climate change, such as flooding or drought, as well as the “stresses to institutions or sectors 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.”

In other words, banks will need to consider their lending priorities with the climate lobby’s preferred policies and predictions in mind, whether or not those predictions are likely to happen.

That would mean reducing exposure to fossil fuels because President Biden has set a goal of eliminating carbon emissions from the power grid by 2035 and achieving a “net-zero” economy by 2050.

Banks will also have to conduct a “climate-related scenario analysis”—don’t call them stress tests—that extend “beyond the financial institution’s typical strategic planning horizon” and account for potential losses in “extreme but plausible scenarios.”

Does this mean anticipating a melting Antarctica? What’s extreme and what’s plausible is far from clear.

As Fed Governor Michelle Bowman notes in dissent, long-dated predictions “are likely to be highly speculative” and “of limited or no utility to the bank in managing risk.”

Banks must hedge all kinds of risks, so why are regulators singling out climate for special treatment?

Perhaps because their goal is to pressure banks to finance the left’s green-energy transition.

Regulators aren’t expressly dictating which industries banks lend or don’t lend to, but examiners will review and grade them on how well they manage putative climate risks. Banks could get penalized if examiners give them bad marks.

The guidance also says management should set “lending limits related to material climate-related financial risks” and consider “the evolving legal and regulatory landscape.”

That sure sounds like a warning to limit fossil fuel financing.

Bank boards must “challenge management’s assessments and recommendations” on climate, regulators say, and “encourage management to consider climate-related financial risk impacts on the financial institution’s other operational and legal risks.”

The clear implication is that banks risk getting sued for not doing enough to address climate change.

Fed Chair Jerome Powell, who voted for the guidance, in a statement said, “It is not the Fed’s role to tell banks which businesses they can and cannot lend to, and this guidance is not intended to do so,” adding the “Federal Reserve is not and will not be a ‘climate policymaker.’”

That’s nice to hear, but regional Fed banks will be implementing the new policy.

Regulators are clearly telling banks and their examiners they need to spend more time and resources prioritizing climate even if there are more material and immediate financial risks.

Read more at WSJ