Framework for evaluating impact of climate change on banks’ risks will be needed, Fed’s Brainard indicates

How banks are taking into account climate-related risk in their modelling and management of credit, market, liquidity, and operational risks will require over time the development of a framework for evaluating their efforts, a Federal Reserve governor said Friday.

Calling creation of such a framework important, Fed Gov. Lael Brainard said in a wide-ranging speech (which also touched on the growing impact of climate change on the economy and financial sector), she said the central bank continues to strengthen its understanding of how banks are measuring and managing climate risks.

Speaking to a conference focusing on the financial system and climate change, sponsored by the Center for American Progress in Washington, D.C., Brainard said that although the transmission channels through which climate risks affect banks are increasingly apparent, quantification of those risks remains challenging.

“To date, measurement efforts have been hampered by data gaps and methodological hurdles, many of which are unique to climate change and contribute to elevated uncertainty in estimates of climate-related risks,” she said. “For instance, assessment of the potential impact of climate change on a bank may require precise data on the geolocation of a counterparty’s assets and operations, as well as information on local weather patterns for those locations. It may also require knowledge of a counterparty’s carbon emissions and of policies in different industries and jurisdictions.”

She called data “at this level of granularity” often unavailable or extremely difficult to acquire. She said that presents challenges in calculating the magnitude of climate-related financial risks.

“Two-thirds of respondents to a recent survey of members of the Basel Committee on Banking Supervision’s Task Force on Climate-Related Financial Risks (TFCR) indicated that they lack sufficiently granular or reliable data necessary to run climate risk assessment models,” she said.

Nevertheless, the Fed Board member said, filling the gaps in the data is critical for measuring the banking industry’s exposure to climate risk and analyzing the implications for financial stability and prudential risks.

She said Fed staff are now participating in a “workstream” (or project) on “bridging the data gaps” hosted by the Network for Greening the Financial System (NGFS), a group of central banks and supervisory authorities formed in 2017 that supports the exchange of ideas, research, and best practices on the development of environment and climate risk management for the financial sector. The Fed announced this week it has joined the NGFS.

Brainard said the NGFS project is tasked with creating a detailed list of gaps in data items at the macroeconomic level, the market level, and the financial market participant level needed to model climate risk.

Gov. Lael Brainard: Strengthening the Financial System to Meet the Challenge of Climate Change