For the first time, the U.S. Federal Reserve (the Fed) has listed climate change as a risk to the U.S. financial system in its 2020 Financial Stability Report. Recognition of the risks posed by climate change is overdue.
Typically, the Fed addresses financial risks as: high asset prices relative to economic fundamentals or historical norms; excessive borrowing by businesses and households; over leveraged banks and other financial institutions; and “runs” on financial institutions leading to “financial panics.”
But now the Fed has listed a new type of financial risk. Climate change.
The Fed identifies real estate as an asset type vulnerable to climate change. Some real estate, the Fed writes, “will be subject to acute hazards such as storm surges associated with rising sea levels and more intense and frequent hurricanes.” (Financial Stability Report, November 2020 p.59).
In 2020, the U.S. has experienced an atypical number of hurricanes and tropical storms causing billions of dollars of damage in each in the Gulf Coast, Florida, and the east coast. The Report points out that such storm damage can ripple through the economy, increasing risks to financial stability.
This Fed Report marks the beginning of evaluating and better understanding “the full scope of implications of climate change for markets, financial exposures, and interconnections between markets and financial institutions.” Importantly the Fed expects banks to have the means and methods to “identify, measure, control and monitor all of their material risks.” For the first time banks will be required to identify climate change risks. This will be challenging to measure.
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