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Climate-Related Financial Risk Management Principles Will Not Just Be for Big Banks

Washington, D.C. (April 5, 2022) - The FDIC recently published a Notice of Proposed Policy Statement titled, “Statement of Principles for Climate-Related Financial Risk Management for Large Financial Institutions,” that seeks to provide a framework for the safe and sound management of large banks’ exposures to climate-related financial risks. While the proposed policy would apply only to the largest commercial banks at this time, the Acting Chairman of the FDIC made it clear that this is an “initial step” and that “all financial institutions, regardless of size, complexity, or business model, are subject to climate-related financial risks,” signaling the broader implications of the new policy. The FDIC proposal tracks verbatim to a similar proposal issued by the Office of the Comptroller of the Currency from December 2021, another indication that all banks, regardless of size, should prepare for implementation of climate-related risk management principles.

The FDIC has provided for a 60-day comment period on the proposed policy statement. The General Principles on which comments are requested are described below.

Governance

Sound governance includes reviewing information necessary to oversee the financial institution, allocating appropriate resources, assigning climate-related financial risk responsibilities throughout the organization (i.e., committees, reporting lines, and roles), and clearly communicating to staff regarding climate-related impacts to the institution’s risk profile. Responsibility and accountability may be integrated within existing organizational structures or by establishing new structures for climate-related financial risks. Where dedicated units are established, the board and management should clearly define these units’ responsibilities and interaction with existing governance structures.

Policies, Procedures, and Limits

Management should incorporate climate-related risks into policies, procedures, and limits to provide detailed guidance on the institution’s approach to these risks in line with the strategy and risk appetite set by the board. Policies, procedures, and limits should be modified when necessary to reflect the distinctive characteristics of climate-related risks and changes to the institution’s activities.

Strategic Planning

As part of forward-looking strategic planning, the board and management should address the potential impact of climate-related financial risk exposures on the institution’s financial condition, operations (including geographic locations), and business objectives over various time horizons.

Risk Management

Climate-related financial risks typically impact financial institutions through a range of traditional types of risk. Management should oversee the development and implementation of processes to identify, measure, monitor, and control climate-related financial risk exposures within the institution’s existing risk management framework. A financial institution should employ a comprehensive process to identify emerging and material risks stemming from the institution’s business activities and associated exposures.

Data, Risk Measurement, and Reporting

Sound climate risk management depends on the availability of relevant, accurate, and timely data. Management should incorporate climate-related financial risk information into the institution’s internal reporting, monitoring, and escalation processes to facilitate timely and sound decision-making across the institution.

Scenario Analysis

Management should develop and implement climate-related scenario analysis frameworks in a manner commensurate to the institution’s size, complexity, business activity, and risk profile. For example, management objectives could include exploring the impacts of climate-related risks on the institution’s strategy and business model, identifying and measuring vulnerability to relevant climate-related risk factors including physical and transition risks, and estimating climate-related exposures and potential losses across a range of plausible scenarios.

Additional Considerations

In addition to these general principles, the policy statement emphasizes that management and boards should consider and incorporate climate-related financial risks when identifying and mitigating all types of risk, including credit risks, liquidity risks, operational risks, legal and compliance risks, and other risks such as interest rate risks.

Applicability to Small Banks

While the policy statement initially applies only to the 33 largest banks in the U.S., all banks, regardless of size, must be prepared to incorporate these policy considerations into its enterprise risk management process. The policy statement makes this clear: “Although all financial institutions, regardless of size, may have material exposures to climate-related financial risks, these draft principles are targeted at the largest financial institutions… The draft principles are an initial step to promote a consistent understanding of the effective management of climate-related financial risks… In keeping with the FDIC’s risk-based approach to supervision, the FDIC intends to appropriately tailor any resulting supervisory expectations to reflect differences in institutions’ circumstances such as complexity of operations and business models.” (Emphasis added.)

As noted above, in his statement approving the issuance of the policy for public comment, Acting Chairman Gruenberg said that “all financial institutions, regardless of size, complexity, or business model, are subject to climate-related financial risks. However, smaller financial institutions, especially community banks, may lack the financial resources and expertise necessary to effectively identify and measure climate-related financial risks. To alleviate burden to smaller financial institutions, at this time, the proposed Statement of Principles would be applicable to large financial institutions with over $100 billion in total consolidated assets.” (Emphasis added.)

Clearly, given these messages and the consistency of the FDIC’s proposal with the OCC’s previously issued statement, all banks, not just those over $100 billion in size, ultimately will need to adhere to these prudential regulator’s policies regarding climate-related risk. Now is the time for boards and management to begin the process of identifying and incorporating risk management policies to reduce and mitigate the risks posed by climate-related changes.

Lewis Brisbois’s financial regulatory and ESG practice attorneys are working with clients on navigating these emerging legal issues and effectively managing business risk. For more information, contact the authors of this alert. Visit our Sustainability & ESG Practice page for more alerts in this area.

Authors:

Thomas A. Brooks, Partner

Jane C. Luxton, Managing Partner - Washington, D.C.

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