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How U.S. Regulators Can Help Community and Regional Banks Address Climate-Related Financial Risks

How U.S. Regulators Can Help Community and Regional Banks Address Climate-Related Financial Risks

Federal banking regulators should incorporate climate-related guidance, information, and analysis in their oversight of small and midsize banks.

In this article
The Federal Deposit Insurance Corporation building is seen.
The Federal Deposit Insurance Corporation building is seen in Washington, April 2, 2023. (Getty/Celal Gunes/Anadolu Agency)

Introduction and summary

A safe, sound, and inclusive banking system serves as a source of strength to the U.S. economy. Banks, credit unions, and thrifts help Americans build wealth: They lend to entrepreneurs to start and grow businesses that hire workers—and then make loans to those workers so they can buy houses and build intergenerational wealth.

A robust regulatory framework is central to ensuring that banks properly manage risks in a way that does not threaten their ability to carry out important economic functions. Since the financial crisis of 2007–2008, much attention has been paid to regulations and standards for the largest U.S. banks whose risky actions exacerbated the crisis. However, the recent collapses of three medium-size banks—Silvergate, Silicon Valley, and Signature—have forced regulators to scrutinize how smaller financial institutions are addressing risks.1

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Community and regional institutions are integral to keeping local economies humming, providing loans and services to areas around the United States that larger banks may overlook. Over the coming months, as policymakers assess the recent instability in the banking sector and make go-forward recommendations, they should consider the full scope of risks that these firms face, including climate-related financial risks.

Climate change poses significant risks to individual financial institutions and to the banking system as a whole.2 According to the National Oceanic and Atmospheric Administration, the United States saw 18 different billion-dollar weather and climate disasters in 2022, with damages totaling about $169.8 billion.3 With these disasters occurring in all geographic regions of the country, banks face potential losses if their borrowers cannot repay loans or face productivity losses, or if collateral is destroyed by storms, fires, and droughts. In addition to these physical risks, banks face climate-related transition risks as consumers and investors increasingly prefer greener companies and that governments at all levels implement policies that facilitate the transition to a low-carbon economy.4 Accordingly, the Financial Stability Oversight Council (FSOC) has declared “climate-related financial risks as an emerging threat to the financial stability of the United States.”5

Recent actions banking regulators have taken to address climate-related financial risks have been primarily concerned with large banks, rather than all banks. Although the largest banks are also the largest financiers of fossil fuel companies,6 they are unlikely to be the banks most affected by climate change and are the ones most able to prepare adequately.7 For example, a community bank with a balance sheet of loans concentrated in one region is at significant risk if many of those loans are affected by a single natural disaster.8 Moreover, many community banks could fail simultaneously as a result of their highly correlated balance sheets, potentially propagating a financial crisis and necessitating a “too-many-to-fail” government bailout.9

In response to the failures of Silicon Valley Bank and other midsize banks, the emergency measures taken by financial agencies—such as the Federal Reserve lending facility, retroactive Federal Deposit Insurance Corporation (FDIC) guarantees for uninsured depositors, and public statements of support from the U.S. Treasury—demonstrate that smaller institutions can also pose systemic risk to the financial system.10 An FDIC study on community bank conditions following major weather disasters of the past two decades found, “Government assistance, insurance proceeds, and other aid were instrumental in reducing the financial consequences of the severe weather events on community banks.”11 Although government intervention may sometimes be necessary to contain the worst effects of a crisis, the assumption of an implicit guarantee where none existed before in lieu of robust financial regulation could create a level of moral hazard and incentivize bank management to engage in risky decision-making.12 Banks must have the requisite framework to internalize the breadth of risks they face, and regulators play key roles in setting rules to address such risks and preventing another crisis from emerging.

While large banks have entire departments dedicated to analyzing risks, smaller firms lack similar bandwidth. To help community and regional banks identify and manage climate-related risks, regulators can apply three mutually reinforcing safety and soundness tools: 1) supervision and supervisory guidance; 2) climate-related disclosures; and 3) scenario analyses. First, regulators can issue preliminary guidance and train examiners to identify and help bankers understand climate-related financial risks. Second, as firms become familiar with regulators’ expectations, climate-related information should be integrated into other supervisory channels such as the CAMELS rating system and quarterly call report forms. Third, regulators can learn from scenario analyses conducted on the largest banks and begin adapting lessons to support smaller institutions.

Types of climate-related financial risks

Physical risk: As described by the Financial Stability Board, physical risk is “the possibility that the economic costs and financial losses from the increasing severity and frequency of extreme climate-change related weather events might erode the value of financial assets, and/or increase liabilities.”13 Additionally, physical risk from climate change can affect firms’ operational resilience and ability to provide services to their customers. For example, operational risk increases when critical infrastructure—such as power grids and telecommunications lines—upon which banks rely is disrupted by climate-induced natural disasters.14 Smaller firms are likely less equipped than their larger counterparts to have the robust technology frameworks or institutional capacity necessary to carry out services during these events.15

Transition risk: Financial institutions already face financial risks if they fail to adapt to the clean energy transition that is underway. The 2022 Inflation Reduction Act will accelerate this transition by significantly reshaping the economic and policy landscapes.16 The law provides substantial new federal funding for programs that will strengthen the U.S. economy’s ability to effectively transition to clean energy in ways that lower costs, promote high-quality domestic jobs, and strengthen public health, particularly in disadvantaged communities. As investors and consumers shift preferences toward a low-carbon economy, carbon-intensive assets may experience abrupt repricing, which could result in losses for exposed banks.

Actions by regulators have focused primarily on the largest banks

The United States’ primary banking and credit union regulators have acknowledged their need to address climate risks within the banking system.17 What’s more, the Office of the Comptroller of the Currency (OCC),18 Federal Deposit Insurance Corporation,19 and Federal Reserve Board20 have proposed initial supervisory guidance to help large banks “make progress toward answering key questions on exposures and incorporating climate-related financial risks into banks’ risk management frameworks.”21

To date, the banking regulators have been mainly focused on addressing the climate risks of large banks, rather than those of all banks. The proposed guidance makes clear that it will only apply to banks with more than $100 billion in consolidated assets.22 This is in spite of the fact that federal regulators supervise many more small banks than large ones.23 Furthermore, these institutions play a critical economic function in communities with fewer financing options, such as rural communities.24 Additionally, in September 2022, the Federal Reserve announced that it would conduct the first climate scenario analysis for the six-largest U.S. banks; results are expected to be published at the end of 2023.25

Interestingly, at the state level, the New York State Department of Financial Services (NYDFS) has proposed climate-related guidance that would apply to all banks.26 But at the federal level, Acting Comptroller of the Currency Michael Hsu has indicated that “it will be a number of years” before regulators address community and regional banks.27

Small financial institutions play a critical role in local economies and communities

Smaller banks serve local economies effectively because they engage in relationship banking with small businesses and individuals to a greater extent than their larger counterparts.28 These banks can more easily lend to “informationally opaque” borrowers with bad or limited credit histories by incorporating information beyond a traditional credit score—for example, knowledge gained from personal interactions, such as a borrower’s character or ability to manage their finances—than can larger institutions with automated underwriting and many layers of credit approval.29

How do community and regional banks differ from the largest banks?

Banks are sometimes categorized by their total asset size. For example, the Federal Reserve defines community banks as those with less than $10 billion in assets and regional banks as those with assets between $10 billion and $100 billion.30 To date, federal banking regulators’ efforts to address climate-related financial risk have focused on firms with more than $100 billion in assets.

Banks may also be characterized by the nature of their business activities. For instance, community banks are generally locally owned and controlled.31 The FDIC also notes that smaller institutions tend to adopt a relationship lending approach that leverages localized expertise to serve individuals and businesses who “do not have the types of credit histories or financial reporting mechanisms that fit the model-based lending approaches used by many larger banks.”32

Geographic areas in which community banks have a larger share of deposits tend to see higher interest rates paid on deposits;33 more, larger, and lower-priced loans than others;34 and better overall economic performance for their communities.35

Although community banks hold only 15 percent of the banking industry’s total loans, they provide “30 percent of all [commercial real estate] loans, 36 percent of small business loans, and 70 percent of agricultural loans,” according to the FDIC.36 As the Federal Reserve Bank of Kansas City noted, they are also “the predominant providers of banking services in rural communities across the country” and provide credit during economic downturns when larger institutions may withdraw capital.37 And when called upon in 2020 to assist the government in extending Paycheck Protection Program (PPP) loans to businesses affected by the COVID-19 pandemic, community banks held a disproportionately large share of PPP loans.38


Safety and soundness tools to help small banks

U.S. financial regulators have a suite of mutually reinforcing types of regulation to promote banks’ safety and soundness and ensure the stability of the nation’s banking system. These tools include examiner supervision of bank management and activities, public disclosure of information to promote market discipline, and scenario analysis to understand and address asset-specific risks. The banking agencies should use these regulatory tools to help community and regional banks understand and address risks when identified.

The recent instability that medium-size banks have caused in the banking sector has forced federal regulators to review the rules and supervisory expectations applicable to smaller institutions.39 Moreover, regulatory changes made in 2018 weakened stress-testing, risk-management, liquidity, and resolution-planning requirements for banks with less than $250 million in assets.40 As policymakers conduct their reviews of the recent bank failures, they should consider the full scope of risks banks face, including climate-related financial risks. The following section reviews available tools and how they could be used to help smaller banks address these risks.


Supervision and supervisory guidance

Given the importance of banking to the real economy, regulators rely on bank supervision and supervisory guidance to ensure these institutions are running safely and soundly. Supervision is the process of “monitoring, inspecting, and examining financial institutions” to ensure they follow the law and operate “in a safe and sound manner.”41 To carry out this mission, examiners from the banking agencies conduct on-site examinations of each bank at least once every 18 months, reviewing their balance sheets, operations, and policies and procedures to ensure that management is not taking excessive risks with funds that are backed by the FDIC’s Deposit Insurance Fund or, ultimately, taxpayers.42

Bank supervision also entails issuing broad-based supervisory guidance to all banks. These documents may inform banks how regulators interpret or apply the law, identify brewing risks within the banking system, or advise banks on how to manage particular risks.43 Together, examinations and supervisory guidance help bank regulators ensure that banks’ boards and executive teams are well-equipped to handle the risks they face.

There are three types of supervisory actions that regulators can take to help small and medium-size banks understand and address climate-related risks.

1 . Issue guidance and preliminary expectations

First, federal regulators should issue new supervisory guidance to community banks explaining how they could face financial risks related to climate change and setting preliminary expectations for how their boards and management should begin identifying and considering those risks. This guidance could be based on existing documents, such as guidance by the New York State Department of Financial Services, which applies to all banks regulated by New York state, not just the largest,44 and by the OCC, FDIC, and Federal Reserve, which applies to banks with consolidated assets above $100 billion. These regulators’ guidance documents lay out principles explaining that large banks should, among other things, ensure that their boards and management “demonstrate an appropriate understanding of climate-related financial risk exposures and their impact on risk appetite to facilitate oversight,” as well as that banks “employ a comprehensive process to identify emerging and material risks stemming from the bank’s business activities and associated exposures.”45

While nominally targeting large institutions, the banking regulators’ principles are sufficiently high level to apply to all banks, regardless of size, location, and business model. Community banks can follow them, even if the means by which they implement principles differ from those of larger institutions.

Alternatively, bank regulators could write new guidance specifically for community and regional banks. Such tailored guidance could detail how supervisory expectations for small banks differ from larger institutions. For example, regulators could limit their initial expectations for addressing climate-related risks to having bank boards conduct qualitative evaluations of how the earth’s rising temperatures affect their existing portfolios, rather than requiring banks to conduct detailed quantitative analyses.

Data limitations are among the most cited challenges firms face with respect to understanding climate-related financial risks.46 Accordingly, the regulators should provide guidance as to what types of information may be useful in helping institutions understand their climate risks as well as how banks may obtain this information. When making loans, banks typically rely on information disclosed by borrowers, and banks should request climate-related information from borrowers. Smaller firms can also leverage their specialized knowledge of the communities that they serve to inform climate-related financial risk assessments.47

It is also essential for banks to ensure that climate risk mitigation efforts do not discriminate against borrowers most affected by climate change. Unfortunately, climate-induced or climate-exacerbated natural disasters and sea level rise have been found to affect low-income communities and communities of color disproportionately.48 A literature review conducted by the Federal Reserve Bank of New York staff found “that regions of the United States that are home to above-average shares of low-income and minority groups are likely to suffer the greatest meteorological effects of climate change.”49 Even more, it found “that low-income and minority Americans are limited in how they may adapt to climate change because they have less access to insurance and are less likely to have access to credit when needed.”50

Decades of legal discrimination and racist housing policies have segregated people of color into neighborhoods with disproportionately high levels of lead exposure, poor air quality, and toxic exposures due to their proximity to landfills, hazardous waste sites, and other industrial facilities.51 According to an Environmental Protection Agency study of the consequences of climate change for socially vulnerable populations, this historic segregation means that today, “Black and African American individuals are 40% more likely than non-Black and non-African American individuals to currently live in areas with the highest projected increases in mortality rates,” as well as “34% more likely to live in areas with the highest projected increases in childhood asthma.” Meanwhile, “Hispanic and Latino individuals are 43% more likely than non-Hispanic and non-Latino individuals to currently live in areas with the highest projected labor hour losses in weather-exposed industries,” and “American Indian and Alaska Native individuals are 48% more likely than non-American Indian and non-Alaska Native individuals to currently live in areas where the highest percentage of land is projected to be inundated due to sea level rise.” The latter are also “37% more likely to live in areas with the highest projected labor hour losses in weather-exposed industries.”52

A number of laws to which banks are subject—including the Equal Credit Opportunity Act, the Fair Housing Act, the Community Reinvestment Act (CRA), and regulations thereunder—address discrimination based on several protected characteristics, including race and age.53 Discrimination may be demonstrated through not only “[o]vert evidence of disparate treatment” but also “[e]vidence of disparate impact.”54 Disparate treatment occurs “when a lender openly discriminates on a prohibited basis,” whereas disparate impact occurs when “a lender applies a racially or otherwise neutral policy or practice equally to all credit applicants, but the policy or practice disproportionately excludes or burdens certain persons on a prohibited basis.”55

Community and regional banks may inadvertently engage in discriminatory practices when addressing other climate-related financial risks. For example, financial institutions engage in “blue-lining” when they refuse to lend in certain neighborhoods due to the area’s heightened risk for climate-related disasters.56 Given community banks’ high proportion of commercial real estate loans relative to their size, for example, they may be more likely to engage in geographic targeting or may use their local expertise to recognize risks on a block-by-block basis.57 Further, as part of any new guidance, regulators should include discussion of how to balance climate risk mitigation and the duty to ensure continued access to affordable credit in climate-affected communities.

Community and regional banks that lack the capital to invest in highly quantitative analyses of their lending may be especially vulnerable to the belief that there is a trade-off between not blue-lining and maintaining safe and sound operations. Although the federal banking regulators’ principles encourage banks to be cognizant of fair lending concerns in managing their climate-related risk, regulators should also train examiners to recognize where discrimination may occur in order to provide more detailed guidance to help community banks avoid running afoul of the law.58 Bank examiners should also speak with bankers about what criteria are used to inform lending decisions in known climate-vulnerable areas.

Additionally, the federal banking agencies should finalize the outstanding CRA rules to ensure that credit flows to low- and moderate-income and other disadvantaged communities to help these communities reduce their fossil fuel emissions while investing in resilience and adaptation measures.59 Providing loans for local projects such as energy-efficient and climate-resilient affordable housing, installation of community solar energy projects, and other activities can reduce local pollution and build community resilience to climate change. In February 2021, the NYDFS issued an industry letter that listed types of activities that would support climate resiliency and could qualify for credit under the CRA, which could serve as a helpful starting point for federal guidance.60

Financial regulators have addressed discriminatory lending for decades and may be in the best position to help small banks balance fair lending and climate risk considerations. However, the systemic effects of climate change on low-income communities and communities of color will require a whole-of-government effort to address.

2. Incorporate climate-related risk into CAMELS ratings

Second, regulators should issue new guidance detailing how they will incorporate climate-related financial risks into the Uniform Financial Institutions Rating System. The rating system, also known as CAMELS, is used by regulators to assess “the soundness of financial institutions on a uniform basis and for identifying those institutions requiring special attention or concern.”61 Examiners assign banks a score of 1 (highest) to 5 (lowest) on six components—Capital adequacy, Asset quality, Management capability, Earnings quantity and quality, adequacy of Liquidity, and Sensitivity to market risk—and provide an overall composite score. Banks place great importance on their CAMELS ratings, as low ratings lead to increased scrutiny from regulators and higher deposit insurance premiums. Plus, given the need for community banks to adequately address the risks from climate change, tying a bank’s CAMELS rating to those efforts will encourage these banks to take climate risks more seriously.62


Capital adequacy

Asset quality

Management capability

Earnings quantity and quality

Adequacy of Liquidity

Sensitivity to market risk

Regulators have provided guidance on various factors that examiners should consider when evaluating banks for each component, and climate risk could easily be incorporated.63 For example, current guidance explains that examiners should consider “balance sheet composition, including the nature and amount of intangible assets, market risk, concentration risk, and risks associated with nontraditional activities,”64 when determining a bank’s capital adequacy score; examiners could consider as part of this whether the bank’s assets are at risk of losing value as markets transition away from fossil fuels. Existing guidance also explains that examiners should consider “the adequacy of, and conformance with, appropriate internal policies and controls addressing the operations and risks of significant activities” to determine a bank’s management score.65 Examiners could also consider whether the bank has sufficient policies for assessing and addressing climate-related financial risk.

The banking regulators should issue new CAMELS guidance detailing how examiners may consider climate risks when evaluating and rating banks. This guidance should explain how climate-related concerns fit into the considerations posed by existing guidance for each component and the composite score and could provide additional climate-specific considerations. Updated CAMELS guidance could help community and regional banks recognize the importance of ensuring that bank management is capable of, and does, appropriately address the climate-related risks banks are facing.

3. Train bank examiners

Third, banking regulators should train examiners not only to ensure that all banks are taking climate risks seriously but also to help smaller banks understand their climate risks and how to mitigate them. Examiners are the regulators’ eyes and ears inside financial institutions, and they “determine if financial institutions follow safe-and-sound banking practices, implement effective internal policies and procedures, and comply with consumer protection, anti-discrimination, and community reinvestment laws and regulations.”66

Examiners must be able to speak effectively with community and regional banks about the climate risks they face, how those risks can affect banks’ safety and soundness, and—because community banks may not have sufficient resources to identify and plan for such risks on their own—resources available to bankers to help them understand how to address those risks effectively. Further, examiners should help bankers understand how institutions may continue extending credit to vulnerable communities in a safe, sound, and nondiscriminatory manner. This could include focusing on how institutions may safely lend for the purchase and installation of residential solar panels and a variety of weatherization activities that are the types of long-term, uncollateralized loans that institutions are traditionally reticent to make.

Climate-related disclosures in call reports

Supervision is only one part of the solution to ensuring that community banks understand and address their climate-related financial risks. Another part is market discipline. Many community banks are corporations and, like other corporations, are funded by investors who purchase shares in the institutions and expect a return on their investments. These investors are unlikely to invest in banking institutions at risk of failure, and their market preferences can incentivize bank managers to institute improved risk management practices.67 To help encourage market discipline to banking institutions, regulators can require banks to publicly disclose information related to their climate-related financial risks. According to the Financial Stability Oversight Council, “Gaps in disclosure … exist with respect to banks,”68 but “[p]ublic, high-quality climate-related disclosures … will better inform investors and market participants about the climate-related risks to those entities.”69 Requiring public disclosures may incentivize banks to reduce exposure to and better manage such risks, as investors may be more inclined to invest in—and large depositors may be more inclined to deposit with—banks that are less likely to be affected by climate-related events and that have plans to address climate-related financial risks adequately.

The banking regulators should ensure that banks of all sizes are measuring and disclosing climate-related financial risks to aid investors and large depositors. To do this, the agencies can update the Consolidated Reports of Condition and Income forms—also known as call reports—with climate-related information. Banks are required to file quarterly call reports with the regulators to let investors, regulators, and the public monitor “the condition, performance, and risk profile of individual institutions and the industry as a whole,”70 and the FSOC has stated that these reports “could benefit from further enhancement and integration with other data sources” to ensure adequate disclosure of climate-related risks.71 Line items could be added to each applicable schedule that details banks’ loans for, or securities backed by, assets subject to physical risk or transition risk. Physical risk factors could be broken out by type of weather event, and transition risk factors could include—but not be limited to—fossil fuel exploration, extraction, and electricity generation. Additional items could include climate-related governance, risk management practices, targets and goals, and portfolios’ environmental impacts and greenhouse gas emissions.

Adding new line items to various disclosures would ultimately benefit community and regional banks, their investors, and depositors by encouraging market discipline. These could be phased in gradually to allow smaller banks to become familiar with the processes necessary to identify and address these risks with guidance from regulators. Still, community and regional banks could begin by asking business borrowers simple questions about their exposure to climate-related financial risk. For example, they could ask whether potential borrowers have facilities located in areas expected to experience severe climate-induced flooding or wildfires. Bankers can also access information about the geographic impacts of climate change through publicly available information. Over time, as climate-related disclosure rules, such as the U.S. Securities and Exchange Commission’s proposed rule,72 are finalized and implemented, best practices and streamlined procedures developed with respect to large banks can be adapted for small and medium-size ones.

Climate scenario analysis

One other tool regulators can use to ensure the safety and soundness of community financial institutions is climate scenario analysis. Scenario analyses are, according to regulators, “exercises used to conduct a forward-looking assessment of the potential impact on an institution of changes in the economy, financial system, or the distribution of physical hazards resulting from climate-related risks.”73 Regulators can provide one or more hypothetical scenarios of the future to run through their models. This would allow institutions and their regulators not only to better understand how banks may fare in future scenarios in which climate change worsens, but it would also allow them to make changes to institutions’ operations to ensure they are resilient should those scenarios come to pass.74

The practice of banks conducting scenario analyses is not new. The Dodd-Frank Wall Street Reform and Consumer Protection Act, which became law in 2010, required all banks with more than $10 billion in consolidated assets (raised to $250 billion in 2018) to “conduct periodic stress tests,”75 and between 2013 and 2020, the Federal Reserve required the largest banks to undertake the Comprehensive Capital Analysis and Review (CCAR) exercise to learn whether they had sufficient capital to withstand potential downturns.76

Meanwhile, other jurisdictions, such as the United Kingdom and the European Union, have already begun using climate scenario analyses to evaluate the effects of climate change on their banks. According to the Bank of England, “Climate risks … are likely to create a drag on the profitability of UK banks and insurers,” and if mitigation and adaptation efforts are not made, “households and businesses vulnerable to physical risks would be especially hard hit.”77 The European Central Bank has similarly noted that “more than 20% of potential losses resid[e] in the holdings of 5% of euro area banks.”78

In the United States, climate scenario analysis can help institutions and their regulators understand banks’ susceptibility to the risks from climate change. In September 2022, the Federal Reserve announced it would conduct the first-ever climate scenario analysis for the largest U.S. banks, with results expected to be published at the end of 2023. The exercise tests firms on two modules: physical risk and transition risk. The physical risk module will focus on “estimating the effect of specific scenarios on residential real estate and commercial real estate (CRE) loan portfolios over a one-year horizon in 2023,” and the transition risk module will analyze “corporate loan and CRE loan portfolios over a 10-year horizon.”79

This inaugural climate scenario analysis is an important step for regulators in beginning to understand and address such risks. Just as happened with the CCAR, future scenarios and models are expected to become more comprehensive as regulators and banks learn from prior years’ analyses and as climate scientists gather additional information. These scenarios should provide for a broad range of plausible outcomes with respect to global emissions, tipping points, and the speed with which the global transition to clean energy occurs, and they should set short-, medium-, and long-term analysis windows.

Scenario analysis can take many forms, and banks that are not participating in the Federal Reserve’s pilot program may already be integrating climate risk into such exercises. Although scenario analysis is important to understanding the climate-related financial risks banks face, analyses should not be required to be conducted by the smallest institutions for the time being. Conducting scenario analyses requires resources and expertise, and regulators can gain knowledge from scenario analyses on these larger institutions that can then be applied to the smallest institutions. Over time, regulators may wish to apply tailored scenario analysis requirements to smaller institutions, but in the short term, regulators should conduct economywide scenario analyses and model the impacts on community and regional banks. Going forward, regulators could limit analyses to institutions with total consolidated assets above a threshold that includes some—but not all—regional banks, such as those with assets from $50 billion to $100 billion.80 Additionally, regulators may wish to develop climate risk simulation models and software to help smaller banks.

Information derived from scenario analyses at larger banks will provide regulators with new options for making institutions and the financial system more resilient in the face of the physical and transition risks that result from climate-related risks. One important option may be climate-related capital risk weights. Banks fund themselves and make loans with various sources of capital, including shareholder equity (the investment by the banks’ owners), corporate debt, and customer deposits. As deposits are federally insured against losses, and debt is borrowed from third parties, banks are incentivized to use these funds—and not equity—to finance risky loans. Capital risk weights are one of the regulators’ tools for setting capital requirements; regulators assign each category of asset a risk weight such that banks must fund increasingly risky loans with increasing percentages of shareholder equity. This is done to make banks think twice before taking unwarranted risks with depositors’ funds that they would not take with those of their shareholders. Accordingly, U.S. government debt—one of the safest assets—has the lowest risk weight and can be funded entirely by depositor funds,81 while some asset-backed securities with the highest risk weights cannot be funded at all with deposits.82

Through climate scenario analyses, regulators may identify certain assets as being riskier than others due to their transition risks—such as thermal coal, which is one of the most carbon-intensive fossil fuels—and may decide to impose additional risk weights on those assets. One scholar, for example, has stated that “a long-term loan to an energy company that derives a majority of its revenue from fossil-fuel related activities might receive” a higher risk weight than “a shorter-term loan to an energy company that derives a quarter of its revenue from fossil-fuel related activities.”83 Similarly, regulators could impose higher risk weights on assets with higher physical risks than others based on, for example, the assets’ geographic locations. These considerations can be applied to regional and community banks, which tend to have greater geographic and sectoral concentration of their loan portfolios. Moreover, additional climate risk weights would incentivize banks to diversify their holdings away from higher risk-weighted activities and toward lower ones.84


The three safety and soundness tools—supervision and supervisory guidance, climate-related disclosures, and scenario analyses—should build on each other to help community banks address the climate-related risks they face. Regulators must initially provide community and regional banks with guidance and preliminary expectations and train examiners to identify and help bankers understand climate risks. Once bankers understand regulators’ expectations, regulators can incorporate climate-related risks into the CAMELS rating system, begin examining banks for their performance, and update call report forms to require the disclosure of climate-related information. Finally, regulators can learn from scenario analyses conducted by the largest banks and apply the lessons learned to community banks.

Although regulators have mostly focused on the largest of banks on the premise that smaller institutions may lack capacity to evaluate climate-related financial risk adequately,85 community and regional banks may be the most at risk from climate change. Climate-exacerbated wildfires, floods, and other natural disasters will greatly affect community banks’ concentrated loan portfolios. Federal regulators must expeditiously help community and regional banks recognize and address the climate-related risks they face.


The authors would like to thank the report’s reviewers and advisers, including Todd Phillips, for their thoughtful insights and contributions.


  1. See, for example, Marc Jarsulic and Alexandra Thornton, “The Role of Leverage in the Failures of Silvergate, Silicon Valley, and Signature Banks,” Center for American Progress, March 16, 2023, available at https://www.americanprogress.org/article/the-role-of-leverage-in-the-failures-of-silvergate-silicon-valley-and-signature-banks/; Federal Deposit Insurance Corporation, “Joint Statement by the Department of the Treasury, Federal Reserve, and FDIC,” Press release, March 12, 2023, available at https://www.fdic.gov/news/press-releases/2023/pr23017.html.
  2. Luiz Awaz Pereira da Silva, “Research on Climate-related Risks and Financial Stability: ‘An Epistemological Break’?”, BIS, May 23, 2019, available at https://www.bis.org/speeches/sp190523.htm.
  3. NOAA National Centers for Environmental Information, “U.S. Billion-Dollar Weather and Climate Disasters,” available at https://www.ncei.noaa.gov/access/billions/ (last accessed April 2023).
  4. Celso Brunetti and others, “Climate-related Financial Stability Risks for the United States: Methods and Applications” (Washington: Board of Governors of the Federal Reserve System, 2022), available at https://doi.org/10.17016/FEDS.2022.043.
  5. Financial Stability Oversight Council, “Report on Climate-Related Financial Risk” (Washington: U.S. Department of the Treasury, 2021), available at https://home.treasury.gov/system/files/261/FSOC-Climate-Report.pdf.
  6. Rainforest Action Network and others, “Banking on Climate Chaos: Fossil Fuel Financial Report” (San Francisco: 2023), available at https://www.bankingonclimatechaos.org/wp-content/uploads/2023/04/BOCC_2023_vFinal-1.pdf.
  7. Catherine Clifford, “60 largest banks in the world have invested $3.8 trillion in fossil fuels since the Paris Agreement,” CNBC Make It, March 24, 2021, available at https://www.cnbc.com/2021/03/24/how-much-the-largest-banks-have-invested-in-fossil-fuel-report.html.
  8. Kristian Blickle, Sarah Ngo Hamerling, and Donald P. Morgan, “How Bad Are Weather Disasters for Banks?” (New York: Federal Reserve Bank of New York, 2021), available at https://www.newyorkfed.org/research/staff_reports/sr990. For disasters at the 90th percentile of damage, “Losses at larger (multi-county) banks are barely affected and their income increases significantly with exposure … For local banks, we do find more negative stability effects from extreme disasters.”
  9. Jeremy C. Kress and Matthew C. Turk, “Too Many to Fail: Against Community Bank Deregulation,” Northwestern Pritzker School of Law Scholarly Commons 115 (3) (2020), available at https://scholarlycommons.law.northwestern.edu/cgi/viewcontent.cgi?article=1442&context=nulr.
  10. See, for example, Board of Governors of the Federal Reserve System, “Federal Reserve Board announces it will make available additional funding to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors,” Press release, March 12, 2023, available at https://www.federalreserve.gov/newsevents/pressreleases/monetary20230312a.htm; Federal Deposit Insurance Corporation, “FDIC Acts to Protect All Depositors of the former Silicon Valley Bank, Santa Clara, California,” Press release, March 13, 2023, available at https://www.fdic.gov/news/press-releases/2023/pr23019.html; U.S. Department of the Treasury, “Joint Statement by the Department of the Treasury, Federal Reserve, and FDIC,” Press release, March 12, 2023, available at https://home.treasury.gov/news/press-releases/jy1337.
  11. John Anderlick and others, “Severe Weather Events and Local Economic and Banking Conditions” (Washington: Federal Deposit Insurance Corporation, 2022), available at https://www.fdic.gov/analysis/cfr/staff-studies/2022-03.pdf.
  12. Jarsulic and Thornton, “The Role of Leverage in the Failures of Silvergate, Silicon Valley, and Signature Banks.”
  13. Financial Stability Board, “Stocktake of Financial Authorities’ Experience in Including Physical and Transition Climate Risks as Part of Their Financial Stability Monitoring” (Basel, Switzerland: 2020), available at https://www.fsb.org/wp-content/uploads/P220720.pdf.
  14. Hilary J. Allen, “Reinventing Operational Risk Regulation for a World of Climate Change, Cyberattacks, and Tech Glitches,” SSRN, January 28, 2023 draft, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4347577.
  15. See generally, for example, Board of Governors of the Federal Reserve System, “Supervision and Regulation Report” (Washington: 2022), p. 24, available at https://www.federalreserve.gov/publications/files/202205-supervision-and-regulation-report.pdf.
  16. Inflation Reduction Act of 2022, Public Law 169, 117th Cong., 1st sess. (August 8, 2022), available at https://www.congress.gov/bill/117th-congress/house-bill/5376/text/rh.
  17. Office of the Comptroller of the Currency, “Principles for Climate-Related Financial Risk Management for Large Banks” (Washington: U.S. Department of the Treasury, 2021), available at https://www.occ.treas.gov/news-issuances/bulletins/2021/bulletin-2021-62a.pdf; Federal Deposit Insurance Corporation, “FDIC Issues Request for Comment on Statement of Principles for Climate-Related Financial Risk Management for Large Financial Institutions,” Press release, March 30, 2022, available at https://www.fdic.gov/news/press-releases/2022/pr22027.html; Board of Governors of the Federal Reserve System, “Federal Reserve Board Issues Statement in Support of the Glasgow Declaration by the Network of Central Banks and Supervisors for Greening the Financial System (NGFS),” Press release, November 3, 2021, available at https://www.federalreserve.gov/newsevents/pressreleases/other20211103a.htm; Todd M. Harper, “Statement on the NCUA’s Proposed Strategic Plan for 2022–2026,” National Credit Union Administration, November 18, 2021, available at https://www.ncua.gov/newsroom/speech/2021/ncua-chairman-todd-m-harper-statement-ncuas-proposed-strategic-plan-2022-2026.
  18. Office of the Comptroller of the Currency, “Principles for Climate-Related Financial Risk Management for Large Banks” (Washington: U.S. Department of the Treasury), available at https://www.occ.treas.gov/news-issuances/bulletins/2021/bulletin-2021-62a.pdf (last accessed April 2023).
  19. Federal Deposit Insurance Corporation, “FDIC Board Matters,” Federal Register 87 (64) (2022), available at https://www.fdic.gov/news/board-matters/2022/2022-03-29-notational-fr.pdf.
  20. Board of Governors of the Federal Reserve System, “Federal Reserve Board Invites Public Comment on Proposed Principles Providing a High-Level Framework for the Safe and Sound Management of Exposures to Climate-related Financial Risks for Large Banking Organizations,” Press release, December 2, 2022, available at https://www.federalreserve.gov/newsevents/pressreleases/other20221202b.htm.
  21. Office of the Comptroller of the Currency, “Principles for Climate-Related Financial Risk Management for Large Banks.”
  22. Federal Deposit Insurance Corporation, “FDIC Board Matters”; ibid.; Board of Governors of the Federal Reserve System, “Federal Reserve Board Invites Public Comment on Proposed Principles Providing a High-Level Framework for the Safe and Sound Management of Exposures to Climate-related Financial Risks for Large Banking Organizations.”
  23. See, for example, Office of the Comptroller of the Currency, “About Us,” available at https://www.occ.treas.gov/about/index-about.html (last accessed April 2023); Federal Deposit Insurance Corporation, “What We Do,” available at https://www.fdic.gov/about/what-we-do/index.html (last accessed April 2023); Board of Governors of the Federal Reserve System, “Annual Report 2020” (Washington: 2020), available at https://www.federalreserve.gov/publications/2020-ar-supervision-and-regulation.htm.
  24. Matt Hanauer and others, “Community Banks’ Ongoing Role in the U.S. Economy” (Kansas City, MO: Federal Reserve Bank of Kansas City, 2021), available at https://www.kansascityfed.org/documents/8159/EconomicReviewV106N2HanauerLytleSummersZiadeh.pdf.
  25. Board of Governors of the Federal Reserve System, “Federal Reserve Board Announces that Six of the Nation’s Largest Banks Will Participate in a Pilot Climate Scenario Analysis,” Press release, September 29, 2022, available at https://www.federalreserve.gov/newsevents/pressreleases/other20220929a.htm.
  26. New York State Department of Financial Services, “DFS Superintendent Harris Proposes Guidance for New York State-Regulated and Mortgage Institutions Relating to Management of Safety and Soundness Risks from Climate Change,” Press release, December 21, 2022, available at https://www.dfs.ny.gov/reports_and_publications/press_releases/pr202212201.
  27. Manifest Climate, “Weekly Round-Up: September 5-9,” September 9, 2022, available at https://manifestclimate.com/blog/weekly-round-up-september-5-september-9/.
  28. Marshall Lux and Robert Greene, “The State and Fate of Community Banking” (Cambridge, MA: Harvard Kennedy School, 2015), available at https://www.hks.harvard.edu/sites/default/files/centers/mrcbg/files/Final_State_and_Fate_Lux_Greene.pdf.
  29. Tim Critchfield and others, “Community Banks: Their Recent Past, Current Performance, and Future Prospects,” FDIC Banking Review Series 16 (3) (2004): 1–56, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=883629.
  30. Board of Governors of the Federal Reserve System, “Community & Regional Financial Institutions,” available at https://www.federalreserve.gov/supervisionreg/community-and-regional-financial-institutions.htm (last accessed April 2023).
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  32. Federal Deposit Insurance Corporation, “Trends in Community Banking” (Washington: 2004), available at https://www.fdic.gov/analysis/archived-research/fyi/051804fyi.pdf.
  33. Robin A. Prager and Timothy H. Hannan, “Do Substantial Horizontal Mergers Generate Significant Price Effects? Evidence from the Banking Industry,” Journal of Industrial Economics 46 (4) (1998): 442–449, available at https://doi.org/10.1111/1467-6451.00082.
  34. Allen N. Berger and others, “The Effects of Bank Mergers and Acquisitions on Small Business Lending,” Journal of Financial Economics 50 (1998), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=137993#:~:text=It%20is%20found%20that%20the%20static%20effects%20of,the%20article%20and%20is%20not%20the%20actual%20abstract; Steven G. Craig and Pauline Hardee, “The Impact of Bank Consolidation on Small Business Credit Availability,” Journal of Banking & Finance 31 (4) (2007), available at https://www.sciencedirect.com/science/article/abs/pii/S0378426606002883; Paola Sapienza, “The Effects of Banking Mergers on Loan Contracts,” Journal of Finance 57 (1) (2002): 329–367, available at https://www.jstor.org/stable/2697842; Mark J. Garmaise and Tobias J. Moskowitz, “Bank Mergers and Crime: The Real and Social Effects of Credit Market Competition,” Journal of Finance 61 (2) (2006): 495–538, available at https://www.nber.org/papers/w11006.
  35. Allen N. Berger, Iftekhar Hasan, and Leora F. Klapper, “Further Evidence on the Link between Finance and Growth: An International Analysis of Community Banking and Economic Performance,” Journal of Financial Services Research 25 (2004): 169–202, available at https://link.springer.com/article/10.1023/B:FINA.0000020659.33510.b7.
  36. Federal Deposit Insurance Corporation, “FDIC Releases New 2020 Community Banking Study,” Press release, December 16, 2020, available at https://www.fdic.gov/news/press-releases/2020/pr20139.html.
  37. Hanauer and others, “Community Banks’ Ongoing Role in the U.S. Economy.”
  38. FDIC Quarterly, “The Importance of Community Banks in Paycheck Protection Program Lending,” 14 (4) (2020), available at https://www.fdic.gov/analysis/quarterly-banking-profile/fdic-quarterly/2020-vol14-4/article1.pdf.
  39. Alan Rappeport, Jim Tankersley, and Lauren Hirsch, “Powell and Yellen Suggest Need to Review Regulations After Bank Failures,” The New York Times, March 22, 2023, available at https://www.nytimes.com/2023/03/22/us/politics/jerome-powell-janet-yellen-bank-regulations.html.
  40. Gregg Gelzinis and Joe Valenti, “The Senate’s Bipartisan Dodd-Frank Rollback Bill” (Washington: Center for American Progress, 2018), available at https://www.americanprogress.org/wp-content/uploads/2018/02/DoddFrankRollbackBill-factsheet.pdf.
  41. Board of Governors of the Federal Reserve System, “Supervising and Regulating Financial Institutions and Activities,” available at https://www.federalreserve.gov/aboutthefed/files/pf_5.pdf (last accessed April 2023).
  42. Legal Information Institute, “12 U.S.C. § 1820(d) – Administration of Corporation,” available at https://www.law.cornell.edu/uscode/text/12/1820 (last accessed April 2023).
  43. Daniel K. Tarullo, “Bank Supervision and Administrative Law,” Columbia Business Law Review 2022 (1) (2022), available at https://journals.library.columbia.edu/index.php/CBLR/article/view/9983.
  44. Linda A. Lacewell, “Re: Climate Change and Financial Risk,” New York State Department of Financial Services, October 29, 2020, available at https://www.dfs.ny.gov/industry_guidance/industry_letters/il20201029_climate_change_financial_risks.
  45. See, for example, Office of the Comptroller of the Currency, “Principles for Climate-Related Financial Risk Management for Large Banks”; Federal Deposit Insurance Corporation, “FDIC Board Matters”; Federal Reserve System, “Principles for Climate-Related Financial Risk Management for Large Banks,” Federal Reserve (December 8, 2021), available at https://www.federalregister.gov/documents/2022/12/08/2022-26648/principles-for-climate-related-financial-risk-management-for-large-financial-institutions.
  46. Daniel O. Beltran and others, “What are Large Global Banks Doing about Climate Change?” (Washington: Board of Governors of the Federal Reserve System, 2023), available at https://www.federalreserve.gov/econres/ifdp/files/ifdp1368.pdf.
  47. Governor Randall S. Kroszner, “‘Community Banks: The Continuing Importance of Relationship Finance’ speech at the America’s Community Bankers Government Affairs Conference, Washington, D.C,” Board of Governors of the Federal Reserve System, March 5, 2007, available at https://www.federalreserve.gov/newsevents/speech/kroszner20070305a.htm.
  48. See, for example, Maya Buchanan and others, “Sea Level Rise and Coastal Flooding Threaten Affordable Housing,” Environmental Research Letters 15 (12) (2020), available at https://iopscience.iop.org/article/10.1088/1748-9326/abb266; Jesse Keenan and Elizabeth Mattiuzzi, “Climate Adaptation Investment and the Community Reinvestment Act” (San Francisco: Federal Reserve Bank of San Francisco, 2019), available at https://www.frbsf.org/community-development/publications/community-development-research-briefs/2019/june/climate-adaptation-investment-and-the-community-reinvestment-act/; NYU Furman Center, “Population in the U.S. Floodplains” (New York: 2017), available at https://furmancenter.org/files/Floodplain_PopulationBrief_12DEC2017.pdf.
  49. Ruchi Avtar and others, “Understanding the Linkages Between Climate Change and Inequality in the United States” (New York: Federal Reserve Bank of New York, 2021), available at https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr991.pdf.
  50. Ibid.
  51. Michela Zonta and Caius Z. Willingham, “A CRA To Meet the Challenge of Climate Change,” Center for American Progress, December 17, 2020, available at https://www.americanprogress.org/article/cra-meet-challenge-climate-change/.
  52. U.S. Environmental Protection Agency, “Climate Change and Social Vulnerability in the United States” (Washington: 2021), available at https://www.epa.gov/system/files/documents/2021-09/climate-vulnerability_september-2021_508.pdf.
  53. See U.S. Department of Justice, “Equal Credit Opportunity Act, 15 U.S.C. 1691,” available at https://www.justice.gov/crt/equal-credit-opportunity-act-3 (last accessed April 2023); Fair Housing Act, Public Law 90, Sec. 284, 90th Cong., 2nd sess. (April 11, 1968), available at https://www.congress.gov/bill/90th-congress/house-bill/2516/text; Community Reinvestment Act, Public Law 95, Sec. 128, 95th Cong., 1st sess. (October 12, 1977), available at https://www.congress.gov/bill/95th-congress/house-bill/6655/text.
  54. Federal Deposit Insurance Corporation, ”Fair Lending Laws and Regulations” (Washington), available at https://www.fdic.gov/resources/supervision-and-examinations/consumer-compliance-examination-manual/documents/4/iv-1-1.pdf (last accessed March 2023).
  55. Ibid.
  56. Lindsey Jacobson, “Banks Consider Climate Risk for Home Loans, a Process Called ‘Underwaterwriting’ or ‘Blue-lining’,” CNBC, September 20, 2021, available at https://www.cnbc.com/2021/09/20/blue-lining-and-underwaterwriting-banks-consider-climate-change-risk.html.
  57. Federal Deposit Insurance Corporation, “FDIC Community Banking Study” (Washington: 2020), available at https://www.fdic.gov/resources/community-banking/report/2020/2020-cbi-study-full.pdf. “The share of CRE loans community banks hold (30 percent of the banking industry’s CRE loans) is large relative to the banks’ representation in the banking industry.”
  58. Federal Deposit Insurance Corporation, “Statement of Principles for Climate-Related Financial Risk Management for Large Financial Institutions,” Federal Register 87 (64) (2022), available at https://www.fdic.gov/news/board-matters/2022/2022-03-29-notational-fr.pdf.
  59. Office of the Comptroller of the Currency, “Community Reinvestment Act: Interagency Notice of Proposed Rulemaking to Implement the CRA,” May 5, 2022, available at https://www.occ.treas.gov/news-issuances/bulletins/2022/bulletin-2022-14.html; Americans for Financial Reform, “RE: Principles for Climate-Related Financial Risk Management for Large Financial Institutions,” February 6, 2023, available at https://ourfinancialsecurity.org/wp-content/uploads/2023/02/Fed-Board-Climate-Supervision_Fair-Lending-Letter-1-1.pdf.
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