The OCC issued draft Principles for Climate-Related Financial Risk Management for Large Banks. The draft principles provide banks with "a high-level framework for the safe and sound management of exposures to climate-related financial risks, consistent with the existing risk management framework described in existing OCC rules and guidance."
The draft principles are intended to support efforts by banks to focus on key aspects of climate risk management and "help bank management make progress toward answering key questions on exposures and incorporating climate-related financial risks into banks' risk management frameworks." The OCC asserted that banks are likely to be affected by both the physical risks associated with climate change and the resulting transition risks. The OCC outlined physical risks as risks to people and property from climate events, such as hurricanes, wildfires, floods, heatwaves and the rise in sea level. Transition risks, meanwhile, were identified as risks presented to the financial sector arising from changes in "policy, consumer and business sentiment, or technologies associated with the changes necessary to limit climate change."
To address these concerns, the OCC set forth six general principals regarding the management of climate-related financial risks for banks to focus on, specifically targeting those banks with over $100 billion in consolidated assets:
- Governance:In general, banks should "demonstrate an appropriate understanding of climate-related financial risk exposures and their impact on risk appetite to facilitate oversight."
- Policies:Bank management "should incorporate climate-related risks into policies, procedures, and limits to provide detailed guidance on the bank's approach to these risks in line with the strategy and risk appetite set by the board."
- Strategic Planning:Banks should "consider material climate-related financial risk exposures when setting the bank's overall business strategy, risk appetite, and financial, capital, and operational plans." Public communications about banks' climate-change strategies should be "consistent with their internal strategies and risk appetite statements."
- Risk Management:Banks should develop and implement "processes to identify, measure, monitor, and control climate-related financial risk exposures within the bank's existing risk management framework." Climate-related financial risks should be assessed "across a range of plausible scenarios and under various time horizons." Various tools and approaches can be used, including "exposure analysis, heat maps, climate risk dashboards, and scenario analysis."
- Data, Risk Measurement:Climate-related financial risk information should be incorporated into banks' "internal reporting, monitoring, and escalation processes." Management should monitor developments in "data, risk measurement, modeling methodologies, and reporting" and "incorporate them into their climate risk management."
- Scenario Analysis: Banks should "develop and implement climate-related scenario analysis frameworks in a manner commensurate to the bank's size, complexity, business activity, and risk profile." Such frameworks should contain "clearly defined objectives that reflect the bank's overall climate risk management strategies." For example, such objectives might include "exploring the impacts of climate-related risks on the bank's strategy and business model, identifying and measuring vulnerability to relevant climate-related risk factors including physical and transition risks, and estimating climate-related exposures and potential losses across a range of plausible scenarios."
The OCC also outlined its views on incorporating climate-related financial risks into banks' risk assessment processes, utilizing standard risk assessment principles of credit risk, liquidity risk, other financial risk, operational risk, legal/compliance risk and other nonfinancial risk.
The OCC invited feedback from the public on the draft principles until February 14, 2022.
The OCC is clearly focused not only on direct risks from climate change (such as coastal flooding, and changes in insurance costs), but also on transition risks that arise from efforts to mitigate and adapt to climate change, such as changes in consumer or investor sentiment, new regulations or international accords, and the like. The OCC leaves open the issue of the timeline for big banks to address these risks.
Banks seeking to comply with the OCC's principles should focus particularly on documenting the process by which they track events in the external world, communicate internally and up-the-chain as to those events, and establish processes for assessing the potential impact of those events. The underwriting and monitoring of real estate portfolios is one important area. In addition to direct risks on real estate that might result from meteorological events such as flooding, banks should also consider transition risks to their real estate portfolios resulting from new municipal regulations such as New York City's Local Law 97, which imposes energy efficiency requirements on building owners.
- OCC Principles for Climate-Related Financial Risk Management for Large Banks
- OCC Bulletin: Risk Management - Principles for Climate-Related Financial Risk Management for Large Banks; Request for Feedback
- House Financial Services Committee Press Release: Waters Applauds FSOC and OCC Actions to Address Climate-Related Financial Risk
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