Fed Taking ‘First Step Toward Pressuring Banks’ Into Restricting Energy Investments With Climate Risk Analysis

Federal Reserve Board Chairman Jerome Powell speaks during a news conference following a meeting of the Federal Open Market Committee (FOMC) in Washington, D.C., on Sept. 21, 2022. (Drew Angerer/Getty Images)

The Federal Reserve has called on prominent American banks to conduct a pilot climate assessment for analyzing how their businesses would be impacted by “climate change,” including a transition to a low-carbon economy, despite worries that the measure will end up limiting investments in traditional energy firms.

During the course of the climate scenario analysis (CSA), the Federal Reserve will engage with the banks to understand challenges they face as well as their approaches to dealing with financial risks stemming from climate change. The Fed will collect and discuss governance and risk management policies, estimates of the potential impact on specific portfolios, data challenges and limitations, and measurement methodologies.

The program has been accused of setting the stage for more Fed intrusion into how banks deal with climate risks, even as Fed Chair Jerome Powell recently dismissed the possibility of the central bank becoming a de facto policymaker on issues related to climate.

The six banks that will participate in the pilot CSA include Bank of America, Goldman Sachs, Citigroup, Morgan Stanley, JP Morgan Chase, and Wells Fargo.

The CSA includes two independent modules, a physical risk module and a transition risk module. In the first module, the aim is to understand the potential harm to property and people due to climate-related events. The transition risk module seeks to understand the stresses the banks might have to undergo during the transition to a low-carbon economy.

“The climate scenarios used in the CSA exercise are neither forecasts nor policy prescriptions. They do not necessarily represent the most likely future outcomes or a comprehensive set of possible outcomes,” a Jan. 17th Fed report (pdf) states.

“Rather, the pilot CSA exercise includes a range of plausible future outcomes that can help build understanding of how certain climate-related financial risks could manifest for large banking organizations and how these risks may differ from the past.”

CSA Calculations, Fed ‘Intrusion’

For the CSA, the Fed will define forward-looking scenarios, including climate, economic, and financial variables. The participating banks are expected to estimate the effect of these scenarios on their loan portfolios over a future time period.

The banks are required to calculate the probability of default, internal risk rating grade, and the loss given default for each loan of the portfolio under the CSA exercise.

The Fed had first announced the pilot CSA program back in September, at which time it attracted criticism from Sen. Pat Toomey (R-Pa.), a ranking member of the U.S. Senate Banking Committee.

Toomey called the pilot CSA exercise the “first step toward pressuring banks” into restricting loans and limiting investments in traditional energy companies and other “disfavored carbon-emitting sectors.”

“There is no risk from global warming that banks aren’t already fully capable of pricing into their decisions, and the Fed’s intrusion into this process only underscores that the real risk is government,” he said, according to a press release on Sept, 29, 2022.

“The real purpose of this program is to ultimately produce new regulatory requirements. While the Fed can call this pilot program by whatever name it may prefer, it sounds exactly like a stress test to me.”

Fed Stance on Climate Policy, GOP Countering Climate Agenda in Business

The banks are required to submit responses to the Fed by July 31. The Fed estimates to publish results from the program by the end of 2023. The central bank will not release any “firm-specific” information.

The Fed has published the CSA rules roughly a week after Powell had insisted that the central bank will not seek to act as a policymaker on climate issues.

While speaking at a panel in Sweden, Powell admitted that the Fed has “narrow but important” responsibilities regarding climate-related financial risks.

“But without explicit congressional legislation, it would be inappropriate for us to use our monetary policy or supervisory tools to promote a greener economy or to achieve other climate-based goals. We are not, and will not be, a ‘climate policymaker,’” he said.

Meanwhile, Republicans are strongly pushing against the climate agenda being forced into the business sector.

In December, six Republicans from the House Judiciary Committee wrote a letter to two executives from a group called Climate Action 100+, alleging potential violation of antitrust laws due to their roles in making some companies pursue environmental, social, and governance (ESG) policies.