Climate Risk: Financial Institutions—What Do You Need to Do Now?

Media coverage on climate change usually centers around a scientific debate about whether it is real and if it will have a profound impact on the world’s financial institutions. What that impact will be, specifically, is not fully known, nor will it be completely known for some time.

Therefore, banking supervisors and the Securities and Exchange Commission (SEC) are urging financial institutions to conduct scenario analyses to evaluate the likely financial, operational, and societal impacts from climate change. Federal Reserve Board Governor Lael Brainard noted recently that these scenario analyses are materially different from the supervisory stress-testing scenarios, which are designed to demonstrate capital adequacy strengths or weaknesses in the financial system. Climate risk scenarios should be designed to explore a financial institution’s susceptibility to climate-related risks.

Before we go too far down the scenario analysis path, it is important to note how financial institutions can be impacted by climate change. As Gov. Brainard notes, financial institutions face two primary risks: physical risk and transition risk. Both can manifest through our traditional risk management types: credit, market, operational, reputational, and liquidity.