Kevin Stiroh: A microprudential perspective on the financial risks of
climate change
Remarks by Mr Kevin Stiroh, Executive Vice President of the Financial Institution Supervision
Group of the Federal Reserve Bank of New York, at the 2020 Climate Risk Symposium, Global
Association of Risk Professionals (delivered via videoconference), 10 November 2020.
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Introduction
Good morning and thank you for the opportunity to participate in GARP's 2020 Climate Risk
Symposium. As shown by the strong turnout today, attention on climate-related financial risks is
clearly growing within finance, both for the private sector and the public sector.
Today, I'll speak about these risks from a microprudential perspective-that is, the impact on
specific financial institutions, particularly banks, and how firms are managing those risks. I'll also
provide a short update on some of the work under way through the Basel Committee's Task
Force on Climate-Related Financial Risks-the TFCR.
Before proceeding, I'll emphasize that I am speaking only for myself and not necessarily the
Federal Reserve System or the Federal Reserve Bank of New York.
Risk Management Perspective
From a supervisory perspective, a primary focus is to ensure that banks operate in a safe and
sound manner and manage risks so they are resilient to a range of shocks. As you know, the
core of effective risk management includes identifying, measuring, and managing traditional
banking risks like credit risk, market risk, operational risk, or liquidity risks. These risks can
materialize from a range of shocks-a recession, a geopolitical event, or a bad actor. And
climate change. The purpose of bank supervision is to ensure that supervised firms are resilient
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to all of these risks.
Banks are becoming increasingly attuned to the heightened financial risks from a changing
climate. These risks can manifest in a number of ways: the impairment of collateral due to
severe weather events; mark-to-market losses from the devaluation of companies with stranded
assets; stress to contractual cash flows as regional shocks are realized; or the reduced
provision of financial services as business strategies adapt. All of these are salient concerns for
financial firms and their supervisors.
Financial firms are now incorporating these risks into existing risks management frameworks.
Many firms view climate change as a cross-cutting risk driver that spans familiar risk categories,
broadly affecting risk management approaches. Moreover, some firms are considering
governance issues, the use of scenarios analysis, disclosure options, and thinking about the
strategic implications of a transition to a more sustainable economy. Understanding the impact of
climate change, however, comes with significant challenges including the long time horizon, data
gaps, the need for new model development, inherent complexity and fundamental uncertainty. All
of this suggests that there is much work ahead of us.
Taskforce on Climate-Related Financial Risks
Just as banks are building awareness of climate-related risks, the supervisory community is
similarly developing capacity in this area. I will now turn my attention to the specific work of the
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Basel Committee's Task Force on Climate-Related Financial Risks (TFCR). The Committee
has noted that climate change may result in physical and transition risks that could impact the
safety and soundness of individual financial institutions and have broader financial stability
implications for the banking system. In response, the Committee established the TFCR to
undertake work on climate-related financial risks in February of 2020. I am acting as a co-chair of
the Task Force, along with Frank Elderson, Executive Director of Supervision at the Netherlands
Bank.
In the first phase of work, the TFCR conducted a stock-take of members' existing regulatory and
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supervisory initiatives on climate-related financial risks. This work highlighted the increasing
focus on climate-related risks. To take the work forward, the TFCR is following a gradual and
sequential approach from a banking supervisory perspective with a current focus on
understanding climate risk transmission channels, as well as methodologies for measuring and
assessing these risks. The TFCR plans to complete these fundamental research initiatives by
mid-2021.
Building on this analytical work, the TFCR will then consider the extent to which climate-related
financial risks are incorporated in the existing Basel Framework and identify effective supervisory
practices to mitigate such risks. The TFCR does not currently have a view on potential prudential
treatments or supervisory expectations related to the mitigation of climate-related financial risks.
Conclusions
The financial sector has taken important steps toward incorporating the financial risks of climate
change into risk management frameworks, strategic discussions, and oversight regimes, but I
think it is fair to say that this work is still in its early days. We all have much to learn with many
challenges ahead of us.
My perspective reflects, in part, the observation that understanding the impact of climate change
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from a risk management perspective is both a complex problem and a complicated one. It is
complex in the sense of many interconnections and feedback loops; the likely existence of
nonlinearities and tipping points; and massive uncertainty about key factors like the timing of climate
impacts, policy choices, technological change, and adaptive responses by consumers and
businesses. All of this tests our capacity to understand and manage the risks. At the same time,
this is a complicated undertaking from an implementation perspective. Success will require us to
process and analyze vast amounts of granular data and aggregate across business lines,
sectors, and jurisdictions; to implement new governance and organizational structures; and to
invest in our workforce to develop new skills and new expertise.
In my view, these challenges are not a reason for a cautious approach, but rather a clear signal
about the scale of the work to be done. Our shared success will depend on meaningful
investments to build capacity and develop new tools, a willingness to innovate and look beyond
traditional approaches, and an unwavering commitment to the public good. In particular, I think it
will require ongoing collaboration between the private and public sectors to push the industry
toward greater resilience to the financial risks of climate change. Discussions like this one are a
critical step in that direction.
Thank you for your attention.