United States: OCC drafts climate risk management principles for major banks
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The OCC published a draft Climate-Related Financial Risk Management Principles for Large Banks. The draft principles provide banks with “a high-level framework for the safe and sound management of climate-related financial risk exposures, consistent with the existing risk management framework outlined in existing OCC rules and guidelines.”
The draft principles aim to support banks’ efforts to focus on key aspects of climate risk management and “help bank management move towards answering key questions about exposures and integrating risk.” climate-related financial instruments in banks’ risk management frameworks”. The OCC asserted that banks are likely to be affected by both the physical risks associated with climate change and the resulting transition risks. The OCC has described physical hazards as risks to people and property related to climatic events, such as hurricanes, wildfires, floods, heat waves and sea level rise. Transition risks, meanwhile, have been identified as risks presented to the financial sector resulting from changes in “policy, consumer and business sentiment, or technology associated with changes needed to limit climate change”.
To address these concerns, the OCC has set out six general principles regarding the management of climate-related financial risks that banks should focus on, specifically targeting banks with more than $100 billion in consolidated assets:
- Governance :In general, banks must “demonstrate an appropriate understanding of climate-related financial risk exposures and their impact on risk appetite to facilitate monitoring.”
- Strategies:The bank’s management “should integrate climate-related risks into 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 the board of directors.
- Strategic planning :Banks should “consider material climate-related financial risk exposures when defining the bank’s overall business strategy, risk appetite and financial, capital and operational plans”. Public communications on banks’ climate change strategies must be “consistent with their internal strategies and risk appetite statements”.
- Risk management:Banks should develop and implement “processes to identify, measure, monitor and control climate-related financial risk exposures within the bank’s existing risk management framework.” Climate-related financial risks should be assessed “across a range of plausible scenarios and at various time horizons”. Various tools and approaches can be used, including “exposure analysis, heatmaps, climate risk dashboards and scenario analysis”.
- Data, risk measurement:Information on climate-related financial risks should be integrated into banks’ “internal reporting, monitoring and escalation processes”. Management should keep track of developments in “data, risk measurement, modeling methodologies and reporting” and “integrate them into their climate risk management.”
- Scenario analysis: Banks should “develop and implement climate-related scenario analysis frameworks in a manner commensurate with the size, complexity, business activity and risk profile of the bank”. These frameworks should contain “clearly defined objectives that reflect the bank’s overall climate risk management strategies”. For example, these objectives could include “exploring the impacts of climate-related risks on the bank’s strategy and business model, identifying and measuring vulnerability to relevant climate-related risk factors, including including physical and transitional risks, and estimating potential climate-related exposures and losses across a range of plausible scenarios.”
The OCC also outlined its views on integrating climate-related financial risks into banks’ risk assessment processes, using standard risk assessment principles of credit risk, liquidity risk , other financial risks, operational risks, legal/compliance risks and other non-financial risks.
The OCC has invited public comments on the draft principles until February 14, 2022.
The OCC clearly focuses not only on direct risks climate change (such as coastal flooding and changes in insurance costs), but also on transition risks that arise from climate change mitigation and adaptation efforts, such as changes in consumer or investor sentiment, new regulations or international agreements, etc. The OCC leaves open the question of the time frame given to the big banks to deal with these risks.
Banks seeking to comply with the OCC principles should focus in particular on documenting the process by which they monitor events in the outside world, communicate internally and upstream about those events, and establish processes to assess the potential impact of these events. The underwriting and monitoring of real estate portfolios is an important area. In addition to the direct risks to real estate that could result from weather events such as flooding, banks should also consider transition risks to their real estate portfolios resulting from new municipal regulations such as New York City Local Law 97which imposes energy efficiency requirements on building owners.
- OCC Principles for Managing Climate-Related Financial Risks for Large Banks
- OCC Bulletin: Risk Management – Principles for managing climate-related financial risks for large banks; Request for comments
- House Financial Services Committee Press Release: Waters Applauds Actions by FSOC and OCC to Address Climate-Related Financial Risks
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