The Fed has reportedly pushed back against an effort by European central bankers to require lenders to disclose ‘their strategies for meeting green commitments.’
In an era when regulators — for some reason, the EPA and the SEC come to mind — are extending their own jurisdiction, particularly where climate policy is involved, it’s good to read that the Fed has reportedly pushed back against an effort by European central bankers to require lenders to disclose “their strategies for meeting green commitments.” These rules would have been agreed to by the Basel Committee on Banking Supervision, the committee that sets international banking standards, albeit indirectly.
The Basel Committee can’t force countries to implement its standards. Instead, its power lies in arriving at a baseline for global rules that individual jurisdictions then develop and enforce. For example, jurisdictions across the world pushed through a range of additional capital requirements that were agreed by the Basel Committee after the global financial crisis of 2008.
Adding credence to this story were some comments that Fed Chairman Jerome Powell made at Stanford the other day, in which he said that “policies to address climate change are the business of elected officials and those agencies that they have charged with this responsibility. . . . The Fed has received no such charge.”
That’s spot on, as is this (via Bloomberg):
In October, the Fed, the FDIC and the OCC issued principles on climate-related financial risk management for large institutions. In response, Fed Governor Christopher Waller said that climate risks weren’t “sufficiently unique or material to merit special treatment relative to other risks.” Governor Michelle Bowman said a specific focus on climate issues “could ultimately distract attention and resources” from “core risks,” including credit and interest rates.
Indeed it could.
As economist John Cochrane has been explaining for some time, such as here in Capital Matters in 2021, there is no particular reason, based on financial considerations anyway, why climate risk should be singled out for special consideration.
Cochrane:
A “risk to the financial system” does not mean that someone, somewhere, someday, might lose money on an unwise investment. A risk to the financial system means an event like 2008: a shock so big, so pervasive, and so fueled by short-term debt that it sparks a widespread run, a wave of defaults, and threatens the ability of the whole system to function. “Financial regulation” means looking at the assets and liabilities of financial institutions to mitigate such a risk. It can at best look a few years in the future.
So, if we use plain English, a “climate risk to the financial system” that “financial regulators” can contain must mean the climate might change so drastically, so abruptly, and so unexpectedly, in the next five years, that the economy tanks so terribly that financial institutions blow through the cushions of equity and long-term debt, to spark a widespread systemic crisis like 2008 or worse.
The trouble is, there is absolutely nothing in even the most extreme scientific speculations to support that possibility. Climate is the probability distribution of weather: the chance of heat and cold waves, floods, fires, and so forth. We know with great precision what the climate will be for the next five years.
Cochrane does not “deny” that there are climate-related risks, but he would not agree that they pose a risk to the financial system, an entirely different question.
Since he wrote that article, there has been a sharp increase in the price of insurance (and/or a decreasing availability of coverage) in certain parts of the country, some of which relates to insurance companies’ assessment of weather/climate-related risk. That’s their call (and I write as someone not happy with how my insurance bill has gone up), although it would be interesting to know how that risk has been assessed. Few, however, would claim that insurers are underpricing climate risk, which would (generally, but not always) be the greater risk to the financial system. And no one can sensibly claim that insurers are ignoring possible increases in weather/climate-related risk.
Those higher rates will also send a message to, among others, lenders, builders, and homebuyers to which they can be expected to react, a message that ought to be taken into account by policy-makers and ought to constitute part of our adaptation to a changing climate, something that humanity has done for millennia. Rather than preoccupying themselves with what the climate might be doing in the year 2100, policy-makers, say, in coastal cities might now decide that the seawall that did not make economic sense in 1980 might do so today.
Cochrane asks (rhetorically) why climate risk should be singled out for this special consideration, a question to which we should already know the answer.
Cochrane:
Climate-policy advocates are turning to financial regulation precisely because presidents and legislatures, accountable to voters, are refusing to impose draconian carbon-killing policies.
“Financial” regulation can come in handy as a way of bypassing the democratic process. It can, for example, be used to reduce the flow of capital to industries (notably the fossil-fuel sector) of which climate policy-makers disapprove. That’s not what they say (often), of course. Instead, writes Cochrane, they maintain that they “worry about the risk of ‘stranded assets,’ ‘transition risks,’ losses in fossil fuel and other legacy industries,” risks that are (if we put transition risks to one side) highly unlikely, unless regulators are prepared to ignore one rather basic reality. As Cochrane puts it, “if you restrict fossil-fuel supply, prices and profits go up, not down.”
Transition risks (in the broad sense) might be worth a closer look by regulators, but, if that approach is taken, they should include what Cochrane describes as climate-policy risk. That would include certain risks that have emerged since Cochrane wrote that article. For example, regulators might want to discourage banks (not that they should need too much discouraging) from overexposure to loans secured on office buildings, a troubled enough sector as it is, in cities where those buildings are (or will be) burdened with expensive climate-related retrofitting obligations.
And then there are the large western auto manufacturers. If the electric-vehicle (EV) transition is imposed as planned in the EU, the U.S., the U.K., and elsewhere, traditional manufacturers might soon find themselves in severe difficulty. They are investing billions on producing EVs that may not sell in the anticipated numbers, and they are doing so at the same time their ability to sell highly profitable conventional cars is squeezed. Maybe banks should be encouraged to limit their exposure to the traditional automakers, and just leave it to the taxpayer to pick up the pieces when the bailouts begin.
Green Central Banking, a nonprofit group that rates central banks on their approach to climate, gives the Fed a D- grade, ranking it above only Turkey, South Africa, Argentina and Saudi Arabia among Group of 20 peers.
Even after reading just that one sentence, I thought that Powell should wear that D- grade with pride. And then I clicked on the link to discover that this grading was from November 2022, when the highest grade awarded (a B) was to France. China had come top in 2021, and Russia (another D-) was rated slightly above the U.S.
On its website, Green Central Banking explains what it wants to encourage:
Central banks have a key role to play in global efforts to reach net-zero targets and avert the climate crisis.
Using the tools already at their disposal, central banks can adjust monetary policy and capital requirements to move investments away from fossil fuels and other high-carbon industries, building a future based on green finance instead.
A future based on green finance.
Okey-dokey.