On March 30, 2022, the Federal Deposit Insurance Corporation (the “FDIC”) issued an opinion regarding a project Statement of Principles for Managing Climate-Related Financial Risks for Large Financial Institutions (there “Principles”). The notice also invites public comment on the proposed principles. The Principles are substantially similar to those issued by the Office of the Comptroller of the Currency on December 16, 2021. As proposed, the Principles would create a high-level framework for the safe and sound management of climate-related financial risk exposures.
As currently proposed, the high level framework would identify six (6) principles to ensure that banks develop an effective climate risk management process. These six (6) principles are generally described below.
Governance – Banks should be able to demonstrate an appropriate understanding of climate-related financial risk exposures and their impact on the bank’s risk appetite. The FDIC notes that good governance includes, among other things, reviewing the information needed to oversee the bank, allocating appropriate resources, assigning responsibility for climate-related financial risks across the bank (i.e. committees, reporting lines and roles) and clear communication to staff about climate-related impacts on the bank’s risk profile.
Policies, Procedures and Limits – Banks would be expected to integrate climate-related risks into their policies, procedures and limits to provide detailed guidance on the bank’s approach to these risks, in line with the strategy and risk appetite defined by board of directors.
Strategic planning – Banks would be expected to consider significant climate-related financial risk exposures when defining the institution’s overall business strategy, risk appetite, and financial, capital and operational plans. As part of forward-looking strategic planning, the board and management should consider the potential impact of climate-related financial risk exposures on the financial position, operations (including geographic locations) and bank’s business objectives over various time horizons. In addition, consideration should also be given to the impacts of climate-related financial risks on stakeholder expectations, institutional reputation, and low-to-moderate income households and communities and other disadvantaged households and communities, including physical damage or access to banking products and services.
Risk management – Banks would be expected to oversee the development and implementation of processes to identify, measure, monitor and control climate-related financial risk exposures within the institution’s existing risk management framework. Banks should use a comprehensive process to identify emerging and significant risks arising from the institution’s business activities and associated exposures. The risk identification process should include input from stakeholders across the organization with relevant expertise (eg, business units, independent risk management, and legal). Risk identification would include the assessment of climate-related financial risks under a range of plausible scenarios and at various time horizons.
Data, risk measurement and reporting – In addition, a bank would be expected to integrate climate-related financial risk information into internal reporting, monitoring and escalation processes to facilitate timely and sound decision-making across the institution. Effective risk data aggregation and reporting capabilities allow management to capture and report material and emerging climate-related financial risk exposures, segmented or stratified by physical and transition risks, depending on complexity and types of exposures. The FDIC notes that data, risk measurement, modeling methodologies, and reporting continue to evolve at a rapid pace, and management should monitor these developments and incorporate them into their climate risk management as appropriate.
Scenario analysis – Bank management should also implement climate-related scenario analysis. “Climate-related scenario analysis” means exercises used to perform a forward-looking assessment of the potential impact on an institution of changes in the economy, financial system, or distribution of physical hazards resulting from climate-related risks. These exercises differ from traditional stress testing exercises which typically assess the potential impacts of transitory shocks on short-term economic and financial conditions. An effective climate-related scenario analysis framework would provide a holistic, forward-looking perspective that banks could apply alongside existing risk management practices to assess the resilience of a bank’s strategy and risk management to changes. structural impacts resulting from climate-related risks.
As part of identifying the above principles, the FDIC also advised that banks should consider the following risk areas when assessing their potential exposure to climate-related risks: (i) credit risk; (ii) liquidity risk; (iii) other financial risk; (iv) operational risk; (v) legal/compliance risk; and (vi) non-financial risk. The FDIC said it intends to issue additional guidance that will clarify these areas of risk.
Although the Principles target the largest banks, i.e. those with total consolidated assets exceeding $100 billion, the FDIC notes that, regardless of their size, small banks can be significantly exposed. climate-related financial risks and banks are expected to implement risk management practices appropriate to the size of the bank and the nature, scale and risk of its activities. The FDIC further notes that it would appropriately tailor the resulting supervisory expectations for smaller institutions to reflect differences in the circumstances of those institutions, such as the complexity of operations and business models.
To read the proposed principles, please click on here.
© 2022 Vedder AwardsNational Law Review, Volume XII, Number 97