On March 29, 2022, the Federal Deposit Insurance Corporation (FDIC) joined multiple other regulators in releasing guidance outlining how financial institutions should measure and plan for potential climate-related financial risk. The FDIC specifically outlined how financial institutions can measure the operational risks posed by climate change and the transition to new energy technologies. This guidance largely mirrors the previous request for information from the Office of the Comptroller of the Currency (OCC) in December 2021, in which the OCC requested feedback on its draft principles addressing climate-related financial risk. Both announcements are designed to support the efforts of financial institutions with more than $100 billion in total consolidated assets to better identify and manage climate-related financial risks. The FDIC is requesting feedback on its guidance by June 3, 2022.
The FDIC’s proposed guidance is in response to its identification of the effects of climate change and the transition to a low-carbon economy, and the impact of both on the safety and soundness of financial institutions and overall stability of the financial system. The FDIC, similar to the OCC announcement, emphasized to financial institutions and their executives how they should incorporate governance, strategic planning, risk management, and scenario analysis into their risk frameworks. These similarities are detailed in Section 2, Draft Principles, and Section 3, Management of Risk Areas, of our January 2022 client alert. The FDIC also provided additional detail regarding potential economic and financial risks stemming from the physical and transition risks of climate change1,2. According to the proposed guidance, examples of these risks include the potential for:
The FDIC observes that if financial institutions are unable to accurately identify, measure, and monitor the physical and transition risks associated with climate change, the resulting adverse effects to the financial system would have widespread negative consequences, and would disproportionately impact the financially vulnerable or low- to moderate-income (LMI) households and communities. The FDIC noted they would be providing additional guidance that will “distinguish roles and responsibilities of boards of directors (boards) and management, incorporate the feedback received on the draft principles, and consider lessons learned and best practices from the industry and other jurisdictions.”
As noted above, the FDIC’s proposed guidance is substantially similar to that of the OCC’s request for feedback on its draft principles. Notable differences, stemming in part from the fact that the FDIC oversees the entire financial system, include:
While the FDIC is focusing on financial institutions with more than $100 billion in assets, all financial institutions should consider aligning their organizations to the proposed principles and make the changes necessary to ensure they are well-positioned to manage climate-related risk. Entities should consider proactively assessing their exposure based on the draft principles and review the areas of risk highlighted by the FDIC as they relate to the entities’ existing risk management framework. This includes identifying and assessing any climate-related enterprise risks not included in their current frameworks that could inhibit compliance with the proposed principles or negatively impact their financial status.
Guidehouse can help financial institutions and management teams assess their risk management frameworks in light of the draft principles proposed by the FDIC. Guidehouse has a deep bench of financial services and climate and energy professionals with decades of public and private sector experience and a strong understanding of the climate environment in which financial institutions operate. Among other capabilities, Guidehouse can quickly review and assess your risk management framework to determine whether it is sound, identify gaps or weaknesses, and provide recommendations to ensure it aligns with the FDIC’s draft principles. Guidehouse is well-equipped to make an individualized assessment of your unique circumstances and offer innovative advice and solutions for responding to potentially heightened regulatory requirements.
Special thanks to Henry Darmstadter for contributing to this article.
1 Physical Risks: Damage to property, infrastructure, and business disruptions, all of which have real effects to the value of property securing financial institutions’ exposures and borrowers’ ability to perform on their obligations.
2 Transition Risks: Companies or sectors may become less competitive in a transition to a low-carbon economy due to policies designed to reduce carbon emissions or carbon equivalents (e.g., carbon pricing), technological advances, and changes in investor and public preferences.