FRB Launches Pilot Climate Scenario Analysis Exercise.
The Board of Governors of the Federal Reserve System (Federal Reserve) has released additional details on its pilot climate scenario analysis exercise (CSA). The Federal Reserve has the responsibility of making institutions aware of potential risks, including those regarding climate change. The CSAs are intended to “advance the ability of supervisors and banks to analyze and manage emerging climate-related financial risks.” The CSA will examine the six largest U.S. banks: Bank of America Corporation, Citigroup Inc., The Goldman Sachs Group, Inc., JPMorgan Chase & Co., Morgan Stanley, and Wells Fargo & Company.[1]
The Federal Reserve recognizes the CSA as an emerging risk-management tool and distinguishes the CSA as separate from its already implemented stress testing, “which is intended to determine whether large banking organizations have sufficient capital to continue lending through an economic recession.” In contrast, CSA is merely exploratory and will not have resulting consequences or supervisory implications.
The Federal Reserve will engage with the banks to understand how they plan to respond to potential challenges. The pilot exercise will include two modules for physical risk scenarios and transition risk scenarios “to gather qualitative and quantitative information about the climate risk-management practices of large banking organizations.” In both modules, the exercise will consider possible socioeconomic trends and governmental policies.
The physical risk module utilizes the Intergovernmental Panel on Climate Change’s research regarding “greenhouse gas emissions concentration trajectories to design its own scenarios.” The exercise will include two categories of physical scenarios: common and idiosyncratic. Banks will be directed to consider additional risks to residential and commercial estate portfolios. The banks will estimate the effects of the scenarios over a one-year period.
The transition risk module analyzes two different scenarios: “Current Policies and Net Zero 2050.” For transitional risks, “banks will consider the impact on corporate loans and commercial real estate portfolios.” The banks will estimate the effects of the scenario over a ten-year period.
The Federal Reserve will not be releasing firm-specific information about the findings of the exercise. The results are not intended to be construed as forecasts, nor do they “necessarily represent the most likely future outcomes or a comprehensive set of possible outcomes.” Instead, the insights gained from the six banks will be published collectively and “used to build understanding of climate-related financial risks” and how to manage them effectively.
[1] https://www.federalreserve.gov/publications/files/csa-instructions-20230117.pdf