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Inter-agency climate risk management principles

31 October 2023 5 min read | By Carolanne Boughton, expert in Climate and Sustainability Strategy

The OCC, FDIC, and FRB have jointly issued final interagency Principles for Climate-Related Financial Risk Management. These principles are for Large Financial Institutions (over $100 billion assets) and provide “a high-level framework for the safe and sound management of exposures to climate-related financial risks.”

Most agree this is a step in the right direction toward managing climate risk and transitioning the financial sector into a lower carbon economy. However, the Principles are only guidance and many industry actors are calling for more prescriptive rules to drive real decarbonization. In the OCC’s Spring 2023 Semi-annual Risk Perspective report, the agency concluded that “large banks overall have significant additional work to do to move [climate-related financial risk management] programs to maturity.” Large financial institutions should leverage the final Principles to close the gaps identified in the OCC observations of large banks’ management of climate risk to foster more robust and proactive risk management frameworks.

In response to public comments, the agencies made a few clarifications to the Principles but the final guidance is substantively the same as the draft language.

Key messages from the agencies’ response to public comments include:

· The guidance does not include language to promote a transition to a lower carbon economy

· The guidance is intended for large financial institutions, and not for community banks

· Financial institutions have a role to play to meet the financial needs of their communities, including low-and-moderate-income (LMI) and other underserved consumers and communities

· An institution’s board and management have important and distinct roles in managing climate-related financial risks

· The materiality of climate risks should be assessed with methods used to analyse other types of emerging and material risks. If identified as material, climate risks should be incorporated into an institution’s risk management framework and considered when identifying and mitigating all types of risk

Key takeaways from the Principles:

Governance

· Management is responsible for insuring there is sufficient expertise to execute an institution’s strategic plan and manage climate-related financial risks

· Climate risk management should be a part of the institution’s existing risk management framework

Policies, Procedures, and Limits

· When identified as material, management should incorporate climate risks into policies, procedures, and limits to ensure alignment with the institution’s strategy and risk appetite

Strategic Planning

· The board should consider material climate risks like any other risks “when setting and monitoring the financial institution’s overall business strategy, risk appetite, and when overseeing management’s implementation of capital plans.”

· The board should consider the knock-on effects of climate risk impacts on other operational and legal risks

· The board and Management should consider how the institution’s climate risk management activities may impact LMI and other underserved communities

Risk Management

· Consider a range of plausible scenarios and time horizons when assessing climate risks

· Incorporate metrics and tools into the risk management framework

Scenario Analysis

· Climate scenario analysis capabilities should be “commensurate to the financial institution’s size, complexity, business activity, and risk profile”

Management of Risk Areas

· Credit Risk: Consider monitoring climate credit risks “through sectoral, geographic, and single-name concentration analyses”

· Liquidity Risk: Understand if climate risk could impact the institution’s liquidity position

· Other Financial Risk: Expect “greater volatility or less predictability” due to climate risks. Leverage the best measurement methodologies available and adapt over time as methodologies mature

· Operational Risk: Consider climate risks’ impact on the institution’s operations, control environment, and operational resilience

· Legal and Compliance Risk: Legal requirements are expected to evolve, for example for flood or disaster-related insurance, but institutions should consider their impact on LMI and underserved consumers when reacting to an evolving legal landscape

Ultimately, the finalized Principles shouldn’t come as a surprise. They strive to include climate risk management among existing risk management best practices, but do not provide prescriptive guidance on how this must be done. Accordingly, financial institutions have flexibility in how they incorporate this guidance into their risk management frameworks. However, more regulatory oversight and climate risk exams are likely on the horizon and financial institutions should be prepared to evidence and report on their climate risk management activities.

If you are interested in learning more, please contact a member of our team.

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