On December 15th, the Wall Street Journal Editorial Board wrote about the “transition risk” posed by a move to a low-carbon economy and cited a report seen by some as a policy roadmap for President-Elect Joseph R. Biden’s administration.
The recent report issued by the Senate Democratic Special Committee on the Climate Crisis predicts climate change will drive down the value of property held as collateral by banks when those assets are repriced to reflect increased physical risks or operating costs. Macroeconomic stress testing of bank capital levels was a tool developed during the Great Recession of 2007-2009 to assess the condition of bank balance sheets and project loan losses. The report calls for the Federal Reserve to use annual stress tests and capital reserve standards to ensure banks and insurance companies assign higher risk to carbon-intensive assets.
A September report issued by a subcommittee of the Commodity Futures Trading Commission did not explicitly recommend new capital standards for banks but warned of a “disorderly repricing of assets” as real estate is devalued by physical risk and a shift away from “non-green” assets that lack sustainability and resilience. The report warns a decline in commercial real estate could lead to reduced local tax revenues, leading to larger implications for the U.S. economy and financial sector.
In a letter last month, the head banking regulator in New York state called on state-regulated financial institutions to integrate climate-change related financial risks to credit, liquidity, reputation, operations, strategy and the market at large.
In July, Morgan Stanley, Citi and Bank of America became the first large U.S. banks to join the Partnership for Carbon Accounting Financials, a Dutch consortium that is a major player in climate stress tests in the Netherlands and United Kingdom.
A research note from the Banking Policy Institute summarized stress tests in the United Kingdom that require a counterparty-level analysis projecting the balance sheet and income statement of each borrower over a 30-50 year climate planning horizon. These projections are used to determine the credit rating of the borrower. The Institute sees the long climate planning timelines and difficulty in predicting the emissions of a particular sector or the future availability of carbon-free technologies as “serious and potentially unsurmountable challenges to using climate stress tests to set capital requirements.”