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Fed Summarizes Bank Pilot Climate Scenario Analysis Exercise  

May 14, 2024

On May 9, the Federal Reserve (Fed) released a summary of the 2023 pilot climate scenario analysis it conducted with Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase; Morgan Stanley, and Wells Fargo. The summary did not provide details about individual banks.

The pilot exercise aimed to understand large banks’ climate risk-management practices and enhance their ability to estimate, monitor, and manage climate-related financial risks.

It comprised two separate and independent modules, a physical risk module and a transition risk module:

• The physical risk module focused on estimating the effect of specific scenarios on residential and commercial real estate loan portfolios over a one-year horizon in 2023. (All banks assessed the impact of a severe hurricane in the Northeast region on their residential and commercial real estate portfolios.)
• The transition risk module focused on estimating the effect of specific scenarios on corporate and CRE loan portfolios over a 10-year horizon from 2023–32.

According to the Fed:

“The exercise highlighted data gaps and modeling challenges that arise when estimating the financial impact of highly complex and uncertain risks over various time horizons.” 

Specifically, the Fed found that participants:

• Had significantly different approaches to the exercise due to different business models, views on risk, access to data, and prior participation in climate scenario analysis exercises in foreign jurisdictions;
• Used existing credit models to estimate the impact of climate-related risks on credit risk parameters, with some banks suggesting that models could be enhanced to better capture climate transmission channels and associated impacts;
• Faced data challenges, including gaps related to real estate exposures, insurance, obligors’ transition risk management, and infrastructure;
• Noted the importance of understanding insurance market dynamics when modeling the impact of physical risk hazards on credit exposures; and
• Worked with third-party vendors, with some noting that the lack of historical data and the proprietary nature of vendor models inhibited their ability to independently assess model performance.

When the Fed announced the pilot exercise in 2022, Republican lawmakers expressed concern that regulators might try to use climate analyses to direct banks toward or away from specific activities.

However, the report stated that:

“The pilot CSA exercise was exploratory in nature and does not have consequences for bank capital or supervisory implications. The Federal Reserve neither prohibits nor discourages financial institutions from providing banking services to customers of any specific class or type, as permitted by law or regulation. The decision regarding whether to make a loan or to open, close, or maintain an account rests with the financial institution, so long as the financial institution complies with applicable laws and regulations.”

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Congressional Outlook 

May 14, 2024

With the election seasons heating up and must-pass items dwindling, Congress will focus on hearings, messaging bills, and legislation to set up for the post-election lame duck session and 2025. Here’s what’s on tap for this week related to financial services.

Oversight of Regulators. The House Financial Services and Senate Banking Committees will convene hearings this week focused on the oversight of financial regulators.

• Witnesses will include Fed Vice Chair Michael Barr, FDIC Chair Martin Gruenberg, and OCC Comptroller Michael Hsu. Gruenberg has reportedly been setting up one-on-one meetings with HFSC and SBC Members as he prepares to testify in the wake of a third-party report on misconduct at his agency.

SEC Legislation. The House Financial Services Committee is expected to vote soon on Republican legislation that would fence in SEC regulations.

• One of the bills, introduced by Rep. Barry Loudermilk (R-GA) would overrule an SEC requirement that securities exchanges provide investors’ personal data as part of CAT reporting except when it’s related to an investigation.
• Another bill that is not yet finalized, led by Reps. Young Kim (R-CA) and Ann Wagner (R-MO), would direct the agency to perform cost-benefit analyses of its rules and review them every five years.

Banking Legislation. The HFSC also plans to vote next week on GOP legislation that would ease regulations on banks.

• Bills expected to be considered include legislation from Rep. Andy Barr (R-KY) that would allow more banks to escape regulations such as the Volcker Rule and debit interchange requirements.
• Other Barr legislation on the agenda would force bank regulators to act on merger applications and require the Fed to review its discount window operations. The markup is also expected to include bills that would curtail the CFPB’s collection of data on small business loans and enforcement of so-called abusive acts and practices

CFTC’s Johnson to Treasury Role. The White House is poised to nominate Kristin Johnson, a Democratic commissioner at the CFTC, to fill a top role at the U.S. Treasury Department overseeing banks. If confirmed, the role as assistant secretary for financial institutions would put Johnson in a senior policy position at Treasury.

Contact David McCarthy (dmccarthy@crefc.org) with questions.

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Fed’s Lisa Cook Remarks on CRE

May 14, 2024

Last Wednesday, Federal Reserve Governor Lisa Cook cited the rise of private credit, the impact of deteriorating CRE assets on small bank portfolios, and cyber risks as top financial stability concerns.

“All told, I view CRE risks currently as sizable but manageable, and I will be paying close attention to the sector in the short and medium run.” -Federal Reserve Governor Lisa Cook

Her remarks, made during a speech at the Brookings Institution in Washington D.C., outlined the Fed’s current assessment of financial stability focusing on four key areas: household and business leverage, financial institution leverage, funding risk, and asset valuations.

Why it matters: Cook is one of the seven members of the Board of Governors of the Federal Reserve, which regulates member banks and has a hand in crafting and approving bank regulation.

What they’re saying: Cook emphasized that CRE encompasses broad asset classes and geographies, and that the Fed is carefully monitoring concentration risk in small and regional banks. Excerpts from her speech are below:

• “CRE is a broad asset class, encompassing multifamily housing, hospitality, retail, warehouses, office buildings, and many other business properties. Accounting for this heterogeneity is important in assessing the risks associated with CRE.”
• “On average, CRE loans make up only about 5%of total assets at large banks but around 30% of assets at smaller banks. Those high concentrations have caused us to step up our supervisory work with community and regional banks that have significant CRE concentrations and to augment our regulatory data for this sector.”
• “For instance, data available from SEC Form 10-Q filings suggest that office exposures account for a small share of most regional banks' CRE loans.”

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