Fed Research Paper Flags Climate Change as Source of Financial Risk

Financial regulators—including the Federal Reserve—are moving to incorporate climate risk assessments in their supervisory activities, according to a new research letter published today by the Federal Reserve Bank of San Francisco. The Fed’s Glenn Rudebusch noted that the agency is approaching the management climate-related risk—including physical risk and transition risk as the world moves to a low-carbon economy—from both a microprudential and macroprudential perspective.

For example, at the microprudential level, the Fed has created the expectation that banks should “monitor all of their material risks, which for many banks are likely to extend to climate risks.” As banks work to monitor these risks, climate scenario analysis may be useful, Rudebusch said. From a macroprudential standpoint, the Fed is continuing to monitor systemic vulnerabilities that could arise from climate change through its financial stability framework, and is considering possible approaches such as climate stress testing.

“The financial impacts of climate change appear even more complex, uncertain, opaque, and persistent,” Rudebusch wrote. “As a result, there is considerable scope for abrupt shifts in perceived climate risks and a rapid repricing of assets threatened by climate change or reliant on carbon emissions. The greater likelihood of such a disruptive, cascading asset repricing could increase financial vulnerabilities. In this way, both the physical and transition risks of climate change could pose a threat to financial stability.”