What will be the next step for banking regulators on climate policy?

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Treasury Secretary Janet Yellen, left, could play a bigger leadership role in White House climate policy now that the removal of Fed nominee Sarah Bloom Raskin means the job of vice president for oversight might be vacant for a while.

Bloomberg

The moderation of climate risk in the financial system and other industries has turned into a political brawl.

Republicans are down hard on the Securities and Exchange Committee’s proposal this week to require climate disclosures in certain publicly traded companies. And earlier this month, GOP pushback led Sarah Bloom Raskin to step down from running for vice president overseeing the Federal Reserve, in part over her past in writing limit the exposure of lenders to the fossil fuel industry.

The partisan battle could intensify. If Republicans regain the House and/or Senate in the midterm elections, they would have more power to thwart the Biden administration’s climate ambitions that would rely on new legislation. At this point, Biden regulators could have as little as two years before the next presidential election to enact the kind of financial climate risk changes they promised.

Given the potential obstacle in Congress and the likelihood that the Fed post will remain vacant for some time, the White House could take advantage of the political leeway granted to the Financial Stability Oversight Board to collect data , change capital requirements and affect the supervisory policy of several agencies. , experts say.

“Regulators have a lot of discretion in interpreting the law,” said Paul Kupiec, senior research fellow in banking regulation at the American Enterprise Institute. “The smart thing about this strategy is that they don’t need any legislation. All they need is for the regulatory community to work on it and start the rule-making process.

Focus on Yellen

Yevgeny Shrago, policy adviser for Public Citizen’s climate program, said the Treasury Department could incorporate climate change into an assessment to determine whether an institution poses systemic risk. Shrago is urging Treasury Secretary Janet Yellen, who leads the FSOC, to take aggressive action.

“We hope she now acts like a Treasury secretary, not like a Fed chair,” he said, referring to Yellen’s previous stint as head of the central bank.

Yellen’s potential influence would primarily lie in his ability to rally the heads of other council agencies, such as the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp., to take coordinated regulatory action.

“The power of the FSOC goes no further than individual agencies, but the agenda-setting power available to the Treasury is valuable and important,” said Hilary Allen, a law professor at American University and an expert. in Financial Stability Regulation who testified before the House Financial Services Committee on climate finance.

To some extent, this is already happening, she says. The FSOC released a report on climate-related financial risks in November, calling climate change an emerging threat to financial stability.

The Treasury has a more concrete ability to influence one of the industries most exposed to climate risk, advocates say – the insurance sector. By the end of the year, the Federal Insurance Office of the department publish a report on climate-related insurance oversight that will attempt to overcome potential barriers, including the insurance company oversight patchwork by state.

Although reports are often seen as bureaucratic exercises, they are an important first step in implementing longer-term changes and can signal that the Treasury is looking carefully at an issue, according to Kupiec.

Nellie Liang, Undersecretary for Home Finance at the Treasury Department, describe the steps towards data collection in the insurance industry and other parts of the financial system in remarks earlier this month.

“The first step in regulation is measurement,” Kupiec said.

Banking regulatory channels

Now that Raskin has stepped down, the position of Fed vice chairman for oversight — which has been vacant since Randal Quarles resigned in late December — will likely remain vacant indefinitely, said David Portilla, partner at Cravath, Swaine & Moore. LLP.

Given the intense opposition to Raskin’s positions on climate, the chance of another climate hawk making it through the nomination process is likely quite slim, said Portilla, who is also a former political adviser to the FSOC.

“Without a vice president for oversight, the Fed is unlikely to pursue aggressive climate-related regulations, stress-testing initiatives, or similar ambitious plans,” he said. “Depending on who is confirmed, those plans might even be unlikely with a vice president.”

This will slow efforts to bring banks into some sort of climate finance regulatory system, but not stop them altogether, experts say.

One of the easiest ways for banking regulators to tackle climate change is through the supervisory review process, Portilla said. Regulators could use their oversight authority to make sure banks consider their climate risk, without making big statements or regulations.

“To change the behavior of banks without setting broad policies, at least publicly, the Fed could instead provide confidential prudential information to banking organizations,” he said. “The Fed generally views itself as having quite broad discretion to provide prudential commentary, and its confidential nature has allowed the Fed to push banks to take action outside of public view.”

In this approach, bank examiners could link climate change to risk management, encouraging banks to consider lending to various climate-exposed sectors or other activities that could be affected by climate change.

Allen said the “most obvious” move for banking regulators would be to increase the countercyclical capital buffer, a cushion the Fed could require from big banks, above the current zero percent. The Fed board could vote to increase the buffer even without a vice president for oversight. However, the odds of that happening are unclear – no current Fed governor has called for such a move.

“Raise that buffer and require banks, which are in a pretty good position these days, to fund themselves with more equity, I think that’s the most fundamental step we should take,” he said. she declared.

What will stick?

Of course, the downside of trying to develop policy through regulators is that a lot can be undone once the administration changes and new regulators are appointed. The Biden administration, for example, backtracked on the overhaul of the Trump-era Community Reinvestment Act.

“The reason these moves are low hanging fruit is that they don’t require legislation and can be done at the discretion of the agency,” Allen said. “So that the agency’s discretion can be reversed.”

But measures such as collecting data, requiring disclosure, or requiring banks to hold assets to offset potential climate losses may have longer-term implications. Once banks and other institutions create processes to comply with regulatory requirements, those rules tend to stick, at least in practice.

“Once you start that process and once that wave is on, it’s so hard to stop,” Kupiec said. “He builds his own life.”

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