In a letter to New York-regulated financial institutions, Superintendent of Financial Services Linda Lacewell outlined the agency's expectations, as well as the rationale behind them. The department is the first banking regulator in the U.S. to explicitly call for banks under its supervision to incorporate climate-related risks into their strategy, risk management and corporate governance.
“Climate change is happening now, and we have to take steps to manage the financial risks now,” Lacewell said in a press release Thursday. “We want to ensure that every institution is managing its own individual risks from climate change, which is critical for the safety and soundness of the financial services industry. By working with the industry and engaging in a dialogue on this serious issue, we are creating a road map for a more sustainable future.”
The department regulates a wide range of large banks, foreign subsidiaries and community financial institutions. They include Bank of New York Mellon, Goldman Sachs Bank USA, M&T Bank, New York Community Bank and Bank of China. It also supervises state-chartered credit unions such as Hudson Valley Credit Union, Muncipal Credit Union and AmeriCU.
State and federal banking regulators have begun to speak out about the connection between serious weather events and the financial system, but until now they have stopped short of asking banks to stress test for climate risks.
That idea, which has already been adopted by central bankers abroad, seemed to be gaining more traction this year when the Commodity Futures Trading Commission released a report outlining the systemic financial risks posed by climate change and some steps to address those risks.
Among those steps, the CFTC subcommittee recommends that banking regulators work closely with the institutions they supervise to undertake climate risk stress testing pilots and explore potential opportunities to be had from a transition to a low-carbon economy.
The New York regulator appears to be the first to take up the challenge. It cited the CFTC’s report in its letter when it called out the physical risks posed by greater flooding and storm surges in particular.
“Regional and community banks … are more vulnerable to regionally concentrated physical risk, including to sudden extreme events,” it wrote, citing the CFTC. “These banks’ property loans tend to be more geographically concentrated than the loans of larger banks. In addition, CRE [commercial real estate] loans constitute a much larger share — nearly a third — of the loan books of small banks.”
The department also called attention to transition risk, or the risks posed by a shift to a low-carbon economy. Whether driven by technology, policy or consumer behavior, a sudden shift away from fossil fuels could result in stranded assets, particularly in energy and other carbon-heavy industries.
It recommends that New York-regulated institutions designate a board member or committee, as well as a senior management function, to oversee climate risk oversight at the firm. That oversight should include an enterprisewide risk assessment that takes into account credit risk, market risk, liquidity risk, reputational risk, operational risk and strategy risk.
The department also recommended that banks and credit unions look to the Task Force for Climate-related Financial Disclosures framework in developing their own climate risk disclosures. Founded by billionaire Michael Bloomberg, the TCFD is an international coalition of experts and executives who have developed a set of voluntary financial disclosures on climate risk.
For its own part, the department said that last year it joined the Network for Greening the Financial System, an international coalition of central bankers and supervisors committed to managing financial risks from climate change. And in May the agency hired its first director of sustainability and climate initiatives, Dr. Yue (Nina) Chen.
“As the global public health pandemic of COVID-19 has made clear, preparation is key to addressing systemic risks,” Lacewell wrote. “By the time a crisis occurs, it is simply too late.”