New York’s state banking regulator issued guidance to regulated banking and lending institutions on managing material financial and operational risks related to climate change.

The guidance, adopted Dec. 21 by the New York State Department of Financial Services (NYDFS), is “designed to support institutions’ efforts to identify, measure, monitor, and control their material climate-related financial and operational risks in a manner consistent with current risk management principles,” according to the regulator’s press release.

The guidance follows up a September 2020 NYDFS industry letter outlining its expectations for regulated entities in New York on managing risks posed by climate change.

The NYDFS did not set a timeline for implementation of the guidance but instead will solicit feedback from regulated entities on their progress and challenges related to addressing climate-related risks through a request for information, to be issued in 2024.

The guidance placed climate-related risks into two general categories: physical risks and transition risks.

Physical risks can take the form of extreme weather, like hurricanes, floods, and wildfires, as well as the chronic change in weather patterns that can cause or exacerbate conditions like sea level rise, flooding and coastal erosion, droughts, and heat waves.

Transition risks involve economic and behavioral shifts driven by policy and regulations, adoption of new technologies, consumer and investor preferences, and changing liability risks.

The effects on regulated entities can be direct or indirect. The guidance cited direct examples like the “revaluation of assets that turn out to be worth less than originally modeled due to changes affecting certain sectors or businesses” or the costs to reinvest in and replace infrastructure affected by impacts of climate change. Indirect risks include regulated entities losing business in a certain geographic area that faces “declining revenue prospects” because of the effects of climate change.

Regulated entities should adopt a strategic approach to incorporating risks posed by climate change into their risk management framework, the guidance said. Strategies should be developed by the entities’ board of directors and management; include an effective risk management governance framework; and be embedded in policies, procedures, and controls across all relevant functions and business units. Entities “should incorporate climate-related financial and operational risks into their internal control frameworks across the three lines of defense,” the guidance said.

As the required data for assessment of climate-related risk might not be captured by existing systems, the guidance said regulated entities should consider enhancing existing systems to “identify, collect, and centralize the data necessary to assess material climate-related financial risks so that these risks can be considered alongside other dynamic risks.”