and technology transitions. the question is not whether these risks could result in losses for individuals the conditions characterized by severe post - war recessions with steep rises in unemployment rates and declining asset prices tend to put significant stress on the balance sheets of the largest banks, making them well suited for a capital stress test. - 6or companies. the question is whether these risks are unique enough to merit special treatment in our financial stability framework. let ’ s start with physical risks. unfortunately, like every year, it is possible we will experience forest fires, hurricanes, and other natural disasters in the coming months. these events, of course, are devastating to local communities. but they are not material enough to pose an outsized risk to the overall u. s. economy. broadly speaking, physical risks could affect the financial system through two related channels. first, physical risks can have a direct impact on property values. hurricanes, fires, and rising sea levels can all drive down the values of properties. that in turn could put stress on financial institutions that lend against those properties, which could lead them to curb their lending, and suppress economic growth. the losses that individual property owners can realize might be devastating, but evidence i ’ ve seen so far suggests that these sorts of events don ’ t have much of an effect on bank performance. 9 that may be in part attributable to banks and other investors effectively pricing physical risks from climate change into loan contracts. for example, recently researchers have found that heat stress — a climate physical risk that is likely to affect the economy — has been priced into bond spreads and stock returns since around 2013. 10 in addition, while it is difficult to isolate the effects of weather events on the broader economy, there is evidence to suggest severe weather events like hurricanes do not likely have an outsized effect on growth rates in countries like the united states. 11 blickle, hamerling, and morgan ( 2021 ) study fema disasters and find that they have an insignificant or small effect on u. s. banks ’ performance. see acharya, johnson, sundaresan, and tomunen ( 2022 ). see linder, peach, and stein ( 2013 ) for a study of the effect of hurricane sandy on the economy. - 7over time, it is possible some of these physical risks could contribute to an exodus of people from certain cities or regions. for example, some worry that rising sea levels could significantly change coastal regions. while the cause

’ t as important as building a financial system that is resilient to the range of risks we face. for example, it is plausible that shocks could stem from things ranging from increasing dependence on computer systems and digital technologies to a shrinking labor force to geopolitical risk. our focus on fundamental vulnerabilities like asset overvaluation, excessive leverage, and liquidity risk in part reflects our humility about our ability to identify the probabilities of each and every potential shock to our system in real time. let me provide a tangible example from our capital stress test for the largest banks. we use that stress test to ensure banks have sufficient capital to withstand the types of severe credit - driven recessions we ’ ve experienced in the united states since there are also unanticipated risks, which makes it all the more important to be comprehensive and effective in mitigating known risks. - 5world war ii. 8 we use a design framework for the hypothetical scenarios that results in sharp declines in asset prices coupled with a steep rise in the unemployment rate, but we don ’ t detail the specific shocks that cause the recession because it isn ’ t necessary. what is important is that banks have enough capital to absorb losses associated with those highly adverse conditions. and the losses implied by a scenario like that are huge : last year ’ s scenario resulted in hypothetical losses of more than $ 600 billion for the largest banks. this resulted in a decline in their aggregate common equity capital ratio from 12. 4 percent to 9. 7 percent, which is still more than double the minimum requirement. that brings us back to my original question : are the financial risks stemming from climate change somehow different or more material such that we should give them special treatment? or should our focus remain on monitoring and mitigating general financial system vulnerabilities, which can be affected by climate change over the longterm just like any number of other sources of risk? before i answer, let me offer some definitions to make sure we ’ re all talking about the same things. climate - related financial risks are generally separated into two groups : physical risks and transition risks. physical risks include the potential higher frequency and severity of acute events, such as fires, heatwaves, and hurricanes, as well as slower moving events like rising sea levels. transition risks refer to those risks associated with an economy and society in transition to one that produces less greenhouse gases. these can owe to government policy changes, changes in consumer preferences,