Powell Says the Fed Isn’t a ‘Climate Policy Maker.’ What That Really Means.

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About the authors: David Arkush is director of Public Citizen’s Climate Program and a fellow at the Roosevelt Institute. In a previous role, he helped pass and implement the Dodd Frank Wall Street Reform and Consumer Protection Act of 2010. Yevgeny Shrago is policy director of Public Citizen’s Climate Program. In previous roles, he has worked as an attorney advisor in the General Counsel’s Office of the Department of the Treasury as well as at the Consumer Financial Protection Bureau’s Office of Supervision Policy.

The U.S. Federal Reserve is not “and will not be, a ‘climate policy maker,’” Federal Reserve Chair Jerome Powell told an audience in Stockholm earlier this month. It’s not clear who’s urging the agency to make climate policy. What is clear—even Powell agrees in principle—is that the Federal Reserve is responsible for addressing climate-related risks to banking and the financial system. On that score, it’s falling far short.

The risks are enormous. The U.S. Financial Stability Oversight Council, the watchdog created after the 2008 economic crisis to monitor and prevent potential new meltdowns, has described climate-related risk as “an emerging threat to financial stability.”

The council’s recent annual report included a dire projection. The increasing frequency and severity of climate-related disasters such as last summer’s Hurricane Ian may make more properties uninsurable. If this happens, it could trigger billions in losses for the banks and government-sponsored enterprises, like Fannie Mae, that ultimately hold the mortgage debt secured by that real estate. Some of those same institutions were closely involved with the bad loans that triggered the 2008 round of crises and bailouts.

Along with these physical impacts, banks must also navigate the current clean-energy transition. If it proceeds at the necessary pace, this economic shift has the potential to be faster and more disruptive than any in human history. Excessive bank lending to industries that fail to adapt, such as fossil fuels, can trigger instability and even the need for bailouts.

By one estimate, if banks continue on their current course of investment, a rapid transition could cause $300 billion in losses from lending to the fossil fuel industry alone, driving up unemployment by almost 4% and requiring a $3.2 trillion bailout. This exposure may help explain why the Federal Reserve chose to ease the requirements for a pandemic-era lending program designed to prop up financial stability in order to allow more oil and gas companies to participate. 

Too many analysts have for decades grossly underestimated the pace of the clean-energy transition. Costs of renewable energy have declined and market penetration has expanded far more quickly than expected, year after year. The adoption of the Inflation Reduction Act and a major package of climate policies in California will dramatically hasten the transition.

The Fed squarely has the authority and responsibility to mitigate physical and transition risks. Congress tasked the Fed with supervising the largest banks for safety and soundness and, under the Dodd-Frank Act, gave it a major role in mitigating threats to financial stability. Powell acknowledged this role in his recent remarks, noting that the Fed has a “narrow, but important responsibility” to require banks to “understand and appropriately manage” climate-related financial risk. 

The Fed has begun to act on that responsibility, although it has only taken baby steps, and done so at a much slower pace than its peers. In late December, the Federal Reserve followed other federal banking regulators in proposing principles for how large banks should manage climate risk. The draft is short on concrete expectations about what banks should actually do, or the consequences if they fail to act. But it is a start. And the regulators have said they will follow up with more detailed guidance.

The European Central Bank, by contrast, has announced that it expects banks to fully implement a more prescriptive set of expectations by 2024, including incorporating climate risk into its internal capital adequacy assessments. The ECB is not acting under a different mandate, nor as a “climate policy maker.” It is acting more assertively because it is taking its safety and soundness mission seriously. It and the Bank of England have found that many European banks are vulnerable to climate-related financial risks and are not prepared to manage them. There is no reason to think U.S. banks are any different.

Narrow, broad—one can characterize the Fed’s role on climate and the financial system however one wants, but it is essential. It’s concerning that Powell’s words and deeds suggest he doesn’t think so, putting him out of step with regulators in similarly situated countries. If that’s the attitude the Fed continues to take, there’s a real chance that U.S. banks and the financial system will hit destabilizing shocks they aren’t prepared for. Let’s hope the majority of the Federal Reserve Board sees the issue differently.

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