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Fed calls for more transparency from financial firms on climate risks

Brian Cheung
·Reporter
·3 min read

The Federal Reserve has added climate change to its list of risks to the financial system, calling on financial firms to improve transparency on how they price climate risks.

The Fed also committed itself to “evaluating and investing” in ways to further explore the impact of severe weather events. In its updated Financial Stability Report, the central bank noted that higher average global temperatures could have serious domino effects.

“Climate change adds a layer of economic uncertainty and risk that we have only begun to incorporate into our analysis of financial stability,” said the report, released Monday afternoon.

The Fed's Financial Stability Repot noted examples of ways that climate change could ripple through the financial system.
The Fed's Financial Stability Repot noted examples of ways that climate change could ripple through the financial system.

The report details ways in which events like storms, floods, and wildfires could lead to instability in financial markets, one example being asset pricing. For example, real estate in areas of rising sea levels may fall sharply in valuation if the frequency and intensity of hurricanes increase. If those assets are not currently priced to those possibilities, a large event could trigger an abrupt reaction that could lead to fire sales. In turn, the volatility could ripple up to real estate loans and mortgage-backed securities - and then the leveraged financial firms that hold them.

The Fed’s formal acknowledgement of climate change risks have been largely spearheaded by Fed Governor Lael Brainard, an Obama-era appointee now rumored to be a top candidate for Treasury Secretary in the Biden administration.

US Federal Reserve Governor Lael Brainard attends a "Fed Listens" event at the Federal Reserve headquarters in Washington, DC, on October 4, 2019. (Photo by Eric BARADAT / AFP) (Photo by ERIC BARADAT/AFP via Getty Images)
The Federal Reserve’s formal acknowledgement of climate change risks have been largely spearheaded by Fed Governor Lael Brainard. (Photo by Eric BARADAT / AFP) (Photo by ERIC BARADAT/AFP via Getty Images)

Although critics have argued that climate change is outside of the Fed’s purview, Brainard has countered that financial stability risks should be considered given the risk of impeding the Fed’s ability to achieve its Congressionally-mandated dual goals of price stability and maximum employment.

“It is vitally important to move from the recognition that climate change poses significant financial stability risks to the stage where the quantitative implications of those risks are appropriately assessed and addressed,” Brainard said in a statement Monday.

The Fed did not clarify how it would encourage a “quantitative” analysis of the consequences of climate change.

The Fed’s Financial Stability Report continued to flag elevated asset prices and higher business and household debt. The report added that banks appeared well-capitalized and broker-dealers did not appear too levered, although the Fed noted post-2008 highs in certain measures of leverage among life insurance companies.

The report said in the near-term, COVID-19 remains a risk to the financial system, with U.S. dollar markets and weakness abroad as possible areas of vulnerability.

The Fed releases the report twice a year, in May and November.

Brian Cheung is a reporter covering the Fed, economics, and banking for Yahoo Finance. You can follow him on Twitter @bcheungz.

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