Today, U.S. Senator Brian Schatz (D-Hawai'i), a member of the Senate Banking Committee and Chair of the Senate Democrats' Special Committee on the Climate Crisis, introduced the Climate Change Financial Risk Act of 2019. The legislation will direct the Federal Reserve ("Fed") to conduct stress tests on large financial institutions to measure their resilience to climate-related financial risks.
"While our federal regulators are legally obligated to manage and reduce risks in the financial system, they have been ignoring the growing financial risks of climate change," said Senator Schatz. "We should not be treating some risks different from others: risks are risks. This bill will push the Fed to do their job and start taking climate risk seriously."
Climate change is increasing the frequency and severity of extreme weather events like floods and wildfires. It is also changing long-term climate patterns in ways that will lower labor productivity, devalue and destroy fixed assets, stress agricultural yields, and ultimately affect every sector of our economy. These impacts will pose risks for financial institutions and the global financial system.
"The climate crisis poses an existential threat to our way of life. Through more frequent and more intense storms, longer wildfire seasons, and so much more, many of the impacts of climate change are obvious, but others are not," said Representative Casten. "Climate-related financial risks pose serious threats to our economy, whether this is due to the physical risks of the crisis or those risks posed to investments in conventional resources by a successful transition to clean energy. Either way, U.S. consumers deserve to have confidence that our financial institutions are adequately prepared for these risks and won't be caught unaware as they were in 2008. This bill is an important step towards ensuring our financial stability. I'm proud to lead this effort alongside a longtime climate champion, Senator Schatz."
Financial institutions face the risk of direct losses from severe weather events and fundamental changes like drought and sea level rise--for example, lower property values from increased flooding--as well as changes in asset values as a result of government policies and consumer preferences for a low-carbon economy. Even though quantifying and managing these risks falls squarely within the Fed's mandate, the Fed is not accounting for climate-related risks in its current stress tests or supervisory regime.
The Climate Change Financial Risk Act would require the Fed to establish an advisory group of climate scientists and climate economists to help develop climate change scenarios for the financial stress tests.
With the input from the advisory group, the Fed will create three stress test scenarios: a 1.5 degree Celsius warming scenario; a 2 degree scenario; and a "business as usual" scenario, which assumes a higher level of warming based on current climate policies. The Fed will conduct stress tests every two years on the same large financial institutions that are currently subject to Comprehensive Capital Analysis and Review (CCAR) stress tests--i.e., firms with more than $250 billion in total consolidated assets.
The biennial tests will require each financial institution to create and update a qualitative plan that describes how the institution will evolve its capital planning practices to limit the financial impacts of future climate risks. Once the tests are complete, the Fed can object to an unreasonable or ineffective climate risk capital plan, and if the Fed objects, the institution will not be able to proceed with capital distributions until the objection is lifted.
U.S. financial regulators are lagging their international peers in attempting to quantify and manage the potentially systemic financial risks posed by climate change. For example, the Bank of England began stress testing the U.K. financial system against climate risks this year; the Dutch central bank recently conducted a stress test of climate risks to the Netherlands' financial system; and Norway's central bank said that climate risks "must be integrated in the risk assessment and hence in the overall assessment of the capitalization and funding of financial institutions."
Citigroup predicts that world economies could lose at least $44 trillion in economic activity by 2060 with 2.5 degrees of warming, and as much as $72 trillion by 2060 in the event of climate inaction.
In the Senate, Schatz's legislation is cosponsored by U.S. Senators Elizabeth Warren (D-Mass.), Chris Van Hollen (D-Md.), Sheldon Whitehouse (D-R.I.), Michael Bennet (D-Colo.), Jeff Merkley (D-Ore.), Cory Booker (D-N.J.), Amy Klobuchar (D-Minn.), Kamala Harris (D-Calif.), and Patty Murray (D-Wash.).
Companion legislation has been introduced in the House of Representatives by U.S. Representative Sean Casten (D-Ill.).
"Climate change poses significant financial risks to the stability of capital markets, and U.S. financial regulators are currently not doing enough to quantify and manage those risks. Ceres commends Sen. Schatz for this legislation and for setting a clear role for the Federal Reserve Board to engage on climate change. Major investors and companies from across sectors are taking action to reduce their own GHG emissions, but progress is not happening fast enough. This proposal will provide the clarity and analysis needed to help the financial industry make smart decisions to accelerate the transition to a low-carbon economy," said Mindy Lubber, President and CEO of Ceres.
"Climate change threatens profitability and shareholder returns of companies in every sector of our global economy. I applaud Senator Schatz for recognizing the necessary leadership of the Federal Reserve, and the role of banks and financial institutions, in addressing these financial losses through science-based climate risk scenarios and enhanced disclosure," said California State Controller Betty Yee.
"Both the physical and transition risks associated with climate change pose a clear threat to the stability of the financial system. The Federal Reserve, FSOC, and other regulators have failed to sufficiently integrate such risks into their supervisory, regulatory, and systemic risk monitoring frameworks," said Gregg Gelzinis, Policy Analyst for Economic Policy at the Center for American Progress. "The stress tests established by this legislation would help ensure that large financial institutions have the capital, internal controls, governance, and risk management capabilities necessary to withstand various climate-related shocks, while continuing to serve businesses and households."
"Leading global investors recognize that climate change represents a systemic risk, and therefore understanding and mitigating that risk is part of their fiduciary duty. Policymakers in countries around the world have been tracking this shift toward sustainable finance, and passing legislation to foster economies that will resist the threats posed by climate change. The United States has historically lagged behind, but now, with Senator Schatz's leadership, there's an opportunity to right the ship. The Climate Change Financial Risk Act of 2019 sets out a series of sensible and necessary requirements to better account for climate-related risks in the U.S. financial system, which is consistent with the positive work we see underway in other markets around the world. We welcome Senator Schatz's bill as a major step forward on sustainable finance policy in the U.S. and hope to see momentum continue in Washington, D.C.," said Fiona Reynolds, CEO of the UN-supported Principles for Responsible Investment (PRI).
The Climate Change Financial Risk Act is supported by the Center for American Progress, Ceres, Public Citizen, the UN-supported Principles for Responsible Investment (PRI), and the Franciscan Action Network.