OCC guidance: Six principles for large banks managing climate risks

That’s the message the Office of the Comptroller of the Currency (OCC) delivered Thursday to banks with more than $100 billion in assets. The agency is seeking feedback on a framework aimed at managing “exposures to climate-related financial risks consistent with existing OCC rules and guidance.”

“Today’s release takes an important, concrete step towards ensuring the safety and soundness of large banks in the face of increasing risks from climate change,” said Acting Comptroller of the Currency Michael Hsu in a press release. “We look forward to the feedback and to working with our interagency peers to develop more detailed guidance next year.”

Many large banks already incorporate climate-related risks into their risk management frameworks, the OCC acknowledged. The framework is meant to help these banks “focus on key aspects of climate-related financial risk management, allowing bank boards of directors and management to identify risks and develop and implement appropriate strategies to mitigate those risks,” according to an OCC bulletin.

The agency’s draft guidance lists six general principles for identifying, measuring, monitoring, and controlling the potential physical and transitional risks posed by climate change to large banks:

1. Governance. A bank’s board and management should understand their institution’s exposure to climate-related financial risk in the short, medium, and long term. Responsibility and accountability for adherence to the bank’s risk management strategy should be clearly defined between the board and management. Management should regularly provide updates to the board on the level and nature of climate-related financial risks to the bank.
2. Policies, procedures, and limits. It is management’s responsibility to incorporate climate-related risks into the policies, procedures, and limits, in line with the strategy and risk appetite set by the board.
3. Strategic planning. “As part of forward-looking strategic planning, the board and management should address the potential impact of climate-related financial risk exposures on the bank’s financial condition, operations (including geographic locations), and business objectives over various time horizons,” the OCC stated. Strategies should “align with and support the bank’s broader strategy, risk appetite, and risk management framework. In addition, where banks engage in public communication of their climate-related strategies, boards and management should ensure that any public statements about their banks’ climate-related strategies and commitments are consistent with their internal strategies and risk appetite statements.”
4. Risk management. Banks should engage in a process to identify, measure, monitor, and control climate-related financial risks and inform management about the materiality of those risks. Tools and approaches to accomplish this task should “include, among others, exposure analysis, heat maps, climate risk dashboards, and scenario analysis,” the guidance said. “… Outputs should inform the risk identification process and the short- and long-term financial risks to a bank’s business model from climate change.”
5. Data, risk measurement, and reporting. “Sound climate risk management depends on the availability of relevant, accurate, and timely data,” the guidance said. “Management should incorporate climate-related financial risk information into the bank’s internal reporting, monitoring, and escalation processes to facilitate timely and sound decision-making across the bank.”
6. Scenario analysis. “[C]limate-related scenario analysis refers to exercises used to conduct a forward-looking assessment of the potential impact on a bank of changes in the economy, financial system, or the distribution of physical hazards resulting from climate-related risks,” the OCC said. These analyses are different from more traditional stress testing exercises that measure effects of short-term financial shocks. Climate-related scenario analysis should provide a comprehensive and forward-looking perspective banks can apply alongside existing risk management practices. Objectives to measure in these analyses “could include, for example, exploring the impacts of climate-related risks on the bank’s strategy and business model, identifying and measuring vulnerability to relevant climate-related risk factors including physical and transition risks, and estimating climate-related exposures and potential losses across a range of plausible scenarios,” the guidance said.

The guidance also identified several areas where climate-related risk could affect a bank’s financial condition, including credit; liquidity; exposure to changing prices driven by market volatility; operations; legal/compliance; and nonfinancial risk found in potential reputational damage, liability, or litigation.

The OCC said it plans to elaborate on these principles in subsequent guidance, digging into the roles and responsibilities of boards and management, best practices from the industry, and comments from the public.

The deadline to provide feedback on the agency’s draft principles is Feb. 14, 2022.