Financial Regulators Finally Recognized the Risk that the Climate Crisis Poses to Our Economy. Now What?

The climate crisis is already having major impacts around the world. Extreme weather events like wildfires and hurricanes are becoming increasingly frequent and severe, devastating the communities in their path. But the threats from climate change reach far beyond physical destruction: The climate crisis could actually crash our entire financial system, sending us into the worst economic collapse since the Great Recession and putting all of us—especially our most vulnerable communities—at risk. After the 2008 crash, Congress passed new laws that gave federal financial regulators the power to rein in Wall Street to ensure that the same reckless banking giants that crashed our economy in ‘08 couldn’t do it again. 

But today, the same banks are at it again. Except this time, instead of pouring money into destabilizing subprime mortgages, they’re bankrolling climate-warming fossil fuel projects to the tune of trillions every year. If regulators don’t act now, these big banks will crash our economy again with their toxic, risky investments. 

A long-awaited report from US financial regulators failed to provide necessary action steps for addressing climate risk. 

Last month, federal regulators finally acknowledged the risk that climate change poses to the financial system in a major report called for by President Biden. This report from the Financial Stability Oversight Council (FSOC), led by Treasury Secretary Janet Yellen, was an important first step toward addressing climate-related financial risks. By recognizing climate change as a systemic risk to the financial system, the report creates the responsibility for each regulatory agency to use all the tools within their authority to protect the economy from climate risks. 

However, the FSOC report was a missed opportunity to initiate concrete actions to address climate risk. Compared to the clear expectations that advocates laid out for the report, our analysis showed that the report met the mark on only two out of 29 key measures of success. The report only explicitly endorsed assessment and disclosure of climate risks. Beyond this, the report merely suggests, in extremely qualified terms, that banking regulators consider incorporating climate risks in other regulatory interventions. Perhaps the most egregious omission in the report is its failure to mention fossil fuels as the main driver of climate risk. US banks are the world’s largest financiers of fossil fuel expansion, which threatens the stability of our financial system and economy. Reducing reckless fossil fuel financing should be a central focus of regulators’ strategy for addressing climate risk, and yet it was nowhere to be found in the FSOC report. 

Looking ahead, there are several significant opportunities for federal regulators to develop policies to address climate risk. Thankfully, they already have all of the tools they need in order to meaningfully combat climate risk, and can get started right away. 

Improve transparency for financial institutions and large corporations. 

Banking regulators, which oversee large banks like Chase and Wells Fargo, should improve publicly available information on banks’ contribution to climate risk so that the public can see how much greenhouse gas emissions come from the companies and projects banks are financing. This kind of transparency is important because it allows people and institutions to make informed decisions about where they invest their money. Meanwhile, corporate regulators can implement similar rules for large public corporations, requiring them to disclose information on their carbon emissions and other environmental impacts.

Build up the financial system’s resilience to climate-related shocks. 

Financial regulators already use stress tests and scenario analyses to measure and analyze how banks would fare under conditions of economic stress. Now, regulators must include climate considerations in these tools in order to understand and strengthen banks’ resilience to emerging climate shocks, ensuring the hard-earned savings of ordinary Americans are safe and sound. 

Make it more difficult for banks to invest in fossil fuels and other risky assets.

Regulators should impose higher capital requirements for riskier, high-carbon assets in order to disincentivize financial institutions from making these kinds of investments. Capital requirements are regulatory standards that limit how much debt banks can use to finance risky activities, such as expanding fossil fuel production. Beyond making it less appealing to invest in high-carbon assets, these requirements also protect financial stability. When banks are required to hold more capital, they are more resilient to economic shocks, and less likely to fail. 

Require financial institutions to align investment portfolios with science-based emissions targets. 

Regulators should institute limits to cap the total amount of greenhouse gas emissions banks are allowed to finance and require each bank’s holdings to align with science-based emissions targets in line with a climate-stable future. 

President Biden must appoint regulators who will take climate risk seriously. 

While financial regulators already have the authority to implement all of the policies needed to appropriately address climate risk, one major obstacle remains: some of these agencies are led by corporate-friendly, climate-skeptical officials who have continued to drag their feet on addressing climate and roll back regulations on Wall Street. President Biden must treat the climate crisis with the urgency it requires by appointing leaders across all federal agencies who will take this responsibility seriously. 

The Federal Reserve, for example, is the most important banking regulator, and could take a lead role in the effort to combat climate-related risks. However, under the leadership of Chair Jerome Powell, the Fed has fallen behind other central banks, and has done very little thus far to meaningfully address these risks. In fact, under Powell’s leadership, things have actually gotten worse. In response to the COVID-19 pandemic, the Fed disproportionately bailed out fossil fuel companies, all but ensuring that a green economic recovery would be nearly impossible. Despite this, President Biden announced that he would renominate Powell to serve another term as Chair. Still, Powell has a chance to turn his climate record around; we will be watching the confirmation process closely to see how he intends to use the Fed’s authority to protect communities, small businesses, pensions, and families from a climate-driven financial crisis. Biden’s decision to elevate Governor Lael Brainard to Vice Chair is encouraging news, as she has shown promising leadership on addressing climate risk, and has the opportunity to steer Powell in the right direction.  

This is also not Biden’s only chance to choose new regulators. There are other crucial vacancies on the Federal Reserve Board of Governors, as well as in the Office of the Comptroller of the Currency, where appointing leaders who will take climate risk seriously is essential. Failure to change course now will almost certainly mean another devastating recession. As the climate crisis continues to devastate communities across the country, time is running out for regulators to intervene. Our global peers are beginning to create rules to address climate risks and establish frameworks for mitigating it. And while these policies are still deeply insufficient, they remain miles ahead of any policies announced by US regulators. 

President Biden has the opportunity to deliver on his climate pledges and ensure a stable economy by tackling the crisis across his administration. Financial regulators are uniquely positioned to help lead the transition to a zero-emission economy and protect the American people from a climate-fueled financial collapse. US voters overwhelmingly support holding Wall Street banks accountable for risky investments, and thankfully, President Biden has the ability to make it happen. Now, we need to make sure the Biden administration takes decisive action to protect our economy from climate-driven collapse. We will be watching. 

ACT NOW:  Tell federal regulators to stop Wall Street from fueling greater climate risks.