For the first time, the Federal Reserve cited the threat of climate change in its biannual Financial Stability Report and said it expects banks to address systemic risks posed by rising global temperatures.
"Uncertainty about the timing and intensity of severe weather events and disasters, as well as the poorly understood relationships between these events and economic outcomes, could lead to abrupt repricing of assets," the Fed warned in its latest report.
While the Fed did not direct banks to start planning for climate-related shocks, it said supervisors expect them "to have systems in place that appropriately identify, measure, control, and monitor all of their material risks, which for many banks are likely to extend to climate risks."
The mention of climate change was welcomed by Federal Reserve Governor Lael Brainard, who is reportedly on the shortlist to become Treasury Secretary in the upcoming Biden administration.
"At present, financial markets face challenges in analyzing and pricing climate risks, and financial models may lack the necessary geographic granularity or appropriate horizons," Brainard said in a statement. "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."
Asked about the report on CNBC, San Francisco Fed President Mary Daly noted on Nov. 10 that her district and other Federal Reserve banks have been studying the financial implications of climate risks for years.
"It's not that we've elevated it to this level, it's that climate change is coming at such rate that it's been naturally elevated to this level," Daly said.
The U.S. West has dealt with historic wildfires this year while Gulf Coast states have suffered billions of dollars in property damage amid a record number of hurricanes.
Fed officials have said they are also learning from fellow regulators around the world on how to integrate climate risks into supervisory frameworks.
The Fed has requested formal membership at the international Network for Greening the Financial System and expects to be accepted, Fed Vice Chairman for Supervision Randal Quarles said at a Senate Banking Committee hearing Nov. 10. The NGFS is a group of central banks and financial regulators collaborating on how to tackle climate change. Currently, the Fed is a participant but not a formal member.
Fed supervisors are also in contact with U.K. and European banking regulators as they get started on adding in climate risks to banks' stress tests, Quarles said.
The Fed report comes on the heels of a separate report released in September by the Commodity Futures Trading Commission calling climate change a "major risk" to the stability of the country's financial system.
As part of a plan to decarbonize the U.S. economy by 2050, President-elect Joe Biden has pledged to require publicly traded companies to disclose their climate risks and emissions levels.