May 16, 2024

Federal Reserve releases pilot climate analysis conducted with major banks

Risk | by Sam Eckhouse, Chief Technology Officer | 2 Minutes

The Federal Reserve released a summary of its findings from a pilot Climate Scenario Analysis (CSA) exercise conducted with major banks including Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, and Wells Fargo.

The results of the exploratory exercise show greater probability of loan default for both commercial and residential real estate, but otherwise didn’t provide a ton of detail. Results were aggregated and did not break out findings by individual banks.

The Fed noted that banks “took a wide range of approaches” to participate and said the exercise “highlighted data gaps and modeling challenges that arise when estimating the financial impacts of highly complex and uncertain risks over various time horizons.”

Although the exercise didn’t provide granular insights, it highlighted the impact of physical climate risk on lending. Regulators and financial institutions recognize these risks and are working to analyze them, though standardizing this analysis will take time.

Loan default more likely

Banks were directed to analyze the impact of a “common” shock, specifically a hurricane, and an “idiosyncratic” shock of their choice, which could include a hurricane, flooding, wildfire, or a combination of these events.

Here are the stats I found most interesting:

  • The probability of loan default due to hurricanes in the Northeast increased by 0.4% for commercial real estate and 0.1% for residential properties.
  • The probability of loan default in other parts of the U.S. increased by 2.6% for commercial and by 1.1% for residential due unspecified “idiosyncratic” climate hazards chosen by the banks. What hazards? Not super clear, but p.16 of the report explained the banks considered a worst-case risk scenario, involving a mix of acute perils like hurricane, flood, wildfire, and storm.

Both of these default numbers come from a worst-case climate peril scenario, defined as a 200-year event for uninsured property.

Banks encountered data gaps

The report noted that banks encountered data gaps when participating in the exercise, and as a result they turned to third-party vendors and public sources to flesh things out.

Banks encountered gaps related to the following types of data:

  • Real estate exposures
  • Insurance
  • Obligors’ transition risk management
  • Infrastructure

“Going forward, participants reported plans to capture additional data from clients, to source data from vendors, and to use proxies where necessary,” the report stated.

Want to get into more detail with your own property, portfolio, or pool of loans? Our team of experts uses data from government, academic and other public and institutional sources, such as the Intergovernmental Panel on Climate Change (IPCC) to show you historical, current, and future real estate exposure from climate hazards like drought, heat, fire, flood, hurricane, and storm.

Learn more about ClimateCheck’s methodology and our solutions for real estate investors, environmental consultants, lenders, insurance companies, and analytics providers.