How to Prepare for Climate Risk Management

Bank regulators refer to two types of risk from climate change:
  1. The physical risks to property or people from extreme weather or changes in climate.
  2. Transitions risks, stemming from extra stress on financial institutions due to climate change-related changes in policy, consumer or business behavior, or technology.

A Commodity Futures Trading Commission subcommittee in 2020 singled out community banks as being especially vulnerable to climate change physical risks because of their concentrations in commercial real estate.

When regulators refer to physical risk from climate change, they are including damage to property, infrastructure, and business disruptions due to acute, climate-related events, such as hurricanes, wildfires, floods, and heatwaves, and chronic shifts in climate, including higher average temperatures, changes in precipitation patterns, sea level rise, and ocean acidification.”

Regulators view this as a safety and soundness issue because such damage could affect the value of property securing bank loans, as well as borrowers’ ability to repay their obligations.

It seems likely that this is the type of risk that community banks should consider first when preparing a climate risk management framework. Minimally, community banks will need specialized weather data, risk measurements, and the ability to assess the impact of climate change on their local communities, and ideally, their loan portfolios.

“Clearly, community banks are going to have to grapple with these issues,” said Amy Friend, a former senior OCC deputy comptroller and chief counsel, during a February Alliance for Innovative Regulator webinar. She noted that physical risks to community banks “could be tremendous” and pose “existential issues” in the future.

Read more in “The Regulatory Push for Community Bank Climate Change Risk Management,”  a new Invictus Group white paper.