On October 24, 2023, US federal banking regulators issued finalized interagency principles for the management and supervision of climate-related financial risks, commonly referred to as the “Climate Principles.” These principles are primarily aimed at larger banking organizations and provide a consistent framework for managing climate-related financial risks. In this article, we examine the key aspects of these finalized principles and explore what lies ahead for the industry.
Final Climate Principles
The Climate Principles, originally proposed in 2021 and 2022, have now been formalized with only a few notable changes. They outline a high-level framework for managing exposures to climate-related financial risks, drawing inspiration from the Basel Committee’s principles for climate risk management and the OCC’s Heightened Standards.
However, unlike the Basel Committee’s 18 clearly defined principles, the Climate Principles are divided into two narratives with commentaries on climate risk management. Here are the key changes made in the final Climate Principles:
1. Applicability: The Climate Principles apply to US banking organizations with over $100 billion in total consolidated assets, including holding companies, banks, and thrifts. This also includes the US operations of foreign banking organizations (FBOs) that meet the threshold. However, the preamble suggests that even smaller organizations may need to consider climate risk management practices, as they could have material exposures to such risks.
2. De-banking Concern: Addressing concerns about the potential impact on certain industries, the final Climate Principles clarify that they do not prohibit or discourage banking organizations from serving specific customer classes or types as permitted by law. Some regulators express concerns that these principles might discourage lending to certain industries.
3. Lending: The final principles emphasize that banking organizations should manage climate-related financial risks while continuing to meet the financial services needs of their communities, including low-and-moderate income and underserved consumers and communities. They should also ensure compliance with fair housing and fair lending laws. Additionally, organizations should review their risk mitigation measures for potential discrimination against consumers based on factors like race, color, or national origin.
4. Roles and Responsibilities: The final Climate Principles clarify the roles of boards of directors and management in overseeing risk-taking activities and executing the strategic plan and risk management framework.
5. Compensation: Unlike the initial proposal, the final principles do not discuss compensation practices concerning the management of climate-related financial risks. However, the regulators stress the importance of sound compensation programs for promoting sound risk management.
6. Materiality: Responding to concerns that organizations might be required to focus on immaterial climate-related risks, the final Climate Principles specify that climate-related financial risks should be incorporated into risk management frameworks only when they are material.
Next Steps
It’s important to note that the Climate Principles, like other supervisory guidance, do not have the force of law in the United States. Instead, the federal banking regulators will use them as common expectations when supervising the safety and soundness of banking organizations. This supervision typically occurs through non-public processes, leaving certain aspects, such as resolving potential conflicts between climate risk management and lending decisions, unclear.
Moreover, two FDIC directors and two Federal Reserve governors dissented when voting on the final Climate Principles, highlighting concerns that focusing on climate-related financial risk may divert attention from core safety and soundness mandates. Organizations affected by these principles should review their risk taxonomies and update control, monitoring, testing, and reporting activities to align with the Climate Principles.
The finalized Climate Principles are a significant step in addressing climate-related financial risks within the banking sector. As the industry evolves and regulators continue to refine their approach, financial institutions should stay vigilant and adapt to meet these new expectations.
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