Washington, D.C. — A new report from the Center for American Progress looks at how bank capital requirements can be an important tool in strengthening the resilience of the financial system to climate-related risks.
While the precise impact of climate change on the financial system is uncertain, it clearly has the potential to cause a financial crisis more profound than the Great Recession. Financial regulators are increasingly paying attention to the global economy’s exposure to climate change and seeking ways to both mitigate climate-related financial risks and ensure the financial system serves as a source of strength to the economy during the transition away from fossil fuels.
In “Addressing Climate-Related Financial Risk Through Bank Capital Requirements,” Gregg Gelzinis, associate director for Economic Policy at the Center for American Progress, writes that one of the most powerful ways that regulators can address the financial sector risks posed by climate change is to integrate climate risk into the bank capital framework. Stronger capital rules for climate-risky exposures and activities would increase the capacity of the banking system to withstand future climate-related losses, limiting the chances of a climate-driven banking crisis and positioning the banking system to support economywide decarbonization.
The report lays out five capital-related steps financial regulators should take to mitigate climate-related financial risks under existing statutory authority:
- Adjust capital risk weights for bank exposures that face acute transition risks.
- Implement a macroprudential climate risk contribution capital surcharge.
- Establish long-term climate stress tests and add near-term climate variables to existing stress tests.
- Integrate additional transition risks and physical risks into capital risk weights.
- Follow climate risks into the shadow banking sector.
“Climate change and the transition away from fossil fuels present an inherently uncertain but potentially cataclysmic challenge to the global economy. Integrating climate risk into the bank capital framework would ensure that the U.S. banking system is a source of strength to the economy during this period of profound change and uncertainty,” said Gelzinis. “Ultimately, inaction poses the most serious risk.”
Read: “Addressing Climate-Related Financial Risk Through Bank Capital Requirements” by Gregg Gelzinis
For more information on this topic or to speak to an expert, contact Julia Cusick at [email protected].