United States:
OCC Drafts Climate Risk Management Principles For Large Banks
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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.
Commentary
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.
Primary Sources
- 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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