Federal Reserve Board Gov. Christopher Waller said climate change poses risks to banks, but not at a scale warranting new regulatory or supervisory standards.
Speaking at an event on Thursday at Spanish university in Madrid, Waller said any attempt to set policies around climate change would be outside the Fed’s statutory authorities and expose the central bank to political scrutiny.
“We have a clear mandate from Congress to have price stability, maximum employment and financial stability,” Waller said during a question and answer session. “What I worry about is when things like this come in the backdoor. These are particular political agendas, potentially one party likes this, the other party does not like this. If it comes in through the backdoor and the Fed starts acting on it, that’s when you start getting attacked.”
During the event, hosted by IE University, the Spanish central bank and the Federal Reserve Bank of St Louis, Waller delivered a speech on climate change and financial stability. In his remarks he argued that the physical changes to weather and the environment as well as transitional risk related to public policies should be treated the same as other external shocks.
“I don’t see a need for special treatment for climate-related risks in our financial stability monitoring and policies. As policymakers, we must balance the broad set of risks we face, and we have a responsibility to prioritize using evidence and analysis,” he said. “Based on what I’ve seen so far, I believe that placing an outsized focus on climate-related risks is not needed, and the Federal Reserve should focus on more near-term and material risks in keeping with our mandate.”
Waller said the Fed is responsible for ensuring that banks can absorb losses during market disruptions and continue providing credit to businesses and households. It is “agnostic” to what those individual disruptions might be, he argued, adding that trying to tailor resiliency measures to precise events would not be an efficient use of time or resources.
Even in its annual stress test, in which the Fed presents banks with a severely adverse economic scenario to evaluate their capital levels, Waller said the Fed does not specify what triggers the shock, but rather what the economic outcomes are. “We don’t care about the cause,” he said.
“If you think about it, there is a huge set of shocks that could hit at any given time. Some of those shocks do hit, but most do not,” Waller said. “Our approach promotes general resiliency, recognizing that we can’t predict, prioritize, and tailor specific policy around each and every shock that could occur.’
Waller’s comments on climate change come as the Fed faces political pressure from both sides on the topic. Progressive groups have called for the Fed to incorporate climate concerns more explicitly into its capital requirements, particularly involving exposures to high carbon-emitting industries, while conservatives have said such a course would amount to the central bank picking winners and losers.
Earlier, Fed Vice Chair for Supervision Michael Barr oversaw the rollout of a climate scenario testing pilot, in which six of the largest banks in the country will have their readiness tested for significant climate events and drastic changes in public policy. Barr said the findings of the pilot program will not be used to amend capital requirements, but could inform future climate-related initiatives.
During his speech, Waller said the most acute impact of a significant weather event, the widespread loss of real estate values in a specific market, could be absorbed by the banking system. He noted that scenario testing already includes sharp declines in asset values and the largest banks withstood the loss of $600 billion in last year’s test and still had an aggregate common equity ratio of more than double the statutory minimum. He added that some elements of climate change, including heat stress, have been priced into contracts for years.
As for risks related to policy transition, Waller said these changes tend to come on gradually and rarely appear out of nowhere.
“Households and businesses are generally well prepared to adjust to slow-moving and predictable changes. As are banks,” he said. “For example, if banks know that certain industries will gradually become less profitable or assets pledged as collateral will become stranded, they will account for that in their loan pricing, loan duration, and risk assessments.”
Waller also noted that when policy changes take place too quickly or prove too restrictive, they are often adjusted in due course.
“When policies are found to have large and damaging consequences, policymakers always have, and frequently make use of, the option to adjust course to limit those disruptions,” he said.
At the moment, Waller said, the Fed is more concerned with specific points of vulnerability within individual banks including leverage, collateral value and — in light of recent distress in the U.S. banking system — an over-reliance on uninsured deposits.
“Those are the kinds of things I’m staring at right now,” he said. “I’m not as worried about climate; I’m worrying about things like banks failing because of bank runs.”