What can the U.S. Federal Reserve do about climate change risk?
BY Staff | May 16, 2019
While other government agencies have the responsibility for preparing for climate change, the Federal Reserve does use its authority and tools to prepare financial institutions for extreme weather events, said chairman Jerome Powell in a letter to senator Brian Schatz.
This response from Powell was sent after Schatz sent a letter asking what the Federal Reserve Board does to identify and manage climate risks in the American financial system. The letter was signed by Schatz and 19 other senators.
In his response, Powell delineated how the Federal Reserve Board monitors financial stability and looks at shocks and vulnerabilities. Major weather events, for example, would represent a shock because they are inherently difficult to predict and could result in major losses to insurance companies and other financial institutions. Vulnerabilities, on the other hand, are issues with the potential to cause more widespread problems within the financial system. In an extreme weather example, the vulnerability caused by the shock would be the capacity of insurers to absorb large loss and how this is connected to the broader financial system.
“Some potential risks are difficult to quantify and especially if they materialize over such a long horizon that methods beyond near-term analysis and monitoring are appropriate,” wrote Powell. “Accordingly, we rely on ongoing research by academics, our staff, and other experts to improve our understanding and measurement of such longer-run or difficult-to-quantify risks.”
As far as the Federal Reserve Board’s supervisory role, Powell noted the guidance it put in place in 1996 meant to ensure bank management takes all relevant risks into account in underwriting and review practices. As well, he cited the board’s participation in the proceedings of the Financial Stability Board. “Of particular interest are efforts to promote enhanced risk management disclosure, particularly for financial institutions that engage in lending to clients in specific geographic areas or specific sectors of the economy,” he said.
Within the Federal Reserve System itself, Powell said the institution accounts for “a variety of extreme events” and noted as an example that there are a number of procedures in place to ensure the continued functionality of the Fedwire services, a transfer system used by financial institutions. “The 12 Reserve Banks routinely test Fedwire business continuity procedures across a variety of contingency situations to ensure timely resumption of operations in the event of a local, regional or wide-scale disruption,” wrote Powell, adding the risk scenarios tested for are updated on an ongoing basis.
Powell also said the research the Federal Reserve Board conducts includes modelling uncertainty and risks of the economic effects of severe weather events, looking at how they could impact consumer and business activity as well as real estate markets.