We need to rely on facts when we measure banks' climate risk

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In a recent American Banker article, "Banks can't measure climate risk? I live it every day," Roishetta Ozane relates her personal experience with a tornado that tore through the offices of the Vessel Project, the disaster relief and environmental justice organization she founded. She speaks of the "broken homes and livelihoods we are trying to pick up" from this event and others. Turning to policy, she observes, "It must be nice to not know what the risks of climate change are, and clearly if you're the CEO of a Wall Street bank or the chairman of the Federal Reserve you get to live in an ivory tower far from the danger and despair." 

Banks and regulators may be more aware of the risks than she realizes, however. They carefully review the available evidence on climate science in order to understand the risks that may be present.

The Intergovernmental Panel on Climate Change, or IPCC, is the United Nations body responsible for assessing the state of scientific knowledge concerning climate change. Its recent report "Climate Change 2021: The Physical Science Basis," is the most current authoritative statement on the physical foundations of climate change. Chapter 11 of the report states that there is "low confidence" that tornadoes have gotten worse over the last 40 years as a result of climate change, although it is likely that hurricane translational speeds have slowed over the U.S., implying more precipitation and flooding.

Climate change

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By Ebrima Santos Sanneh

May 9

Banks and regulators will typically measure the climate risks of banks by performing stress tests that assume climate risks are worse than they are today, usually by assuming that future climate conditions will hold. For example, the Fed's climate scenario exercise that Ozane referred to required banks to undergo a highly complex and thorough climate scenario exercise. The results of the exercise yielded important insights into the climate risks faced by banks. The exercise revealed that extreme weather events 30 years from now would produce relatively small risks for the banks tested, giving comfort that a banking system that is resilient to climate risks will be able to perform its necessary lending function following an extreme weather event.

Ozane is certainly right to focus attention on the suffering that extreme weather events inflict on underserved communities. There, she should see the nation's banks as an ally. When banks lend after a weather disaster, homes can be rebuilt to current building standards, reducing the risk of future damage in extreme weather events. Rebuilding to current building standards also lowers insurance costs. The research article "Tracing out capital flows: how financially integrated banks respond to natural disasters," published in the Journal of Financial Economics in 2017, tells the story. After a natural disaster, local banks increase their lending by about 25%, with the lion's share going to mortgage loans. Banks generally increase their lending for six months following a disaster.

Climate change poses great risks to our civilization, and those risks should be studied and reduced through responsible legislation and voluntary private sector efforts. Those risks, however, at this point do not appear to include significantly worsening weather events that are causing losses to banks. Direct regulation of the cause of climate change is appropriate; identifying false risks to the banking system is not.