The Federal Reserve yesterday warned for the first time that climate change has the potential to disrupt global financial stability.
To reduce the likelihood of that outcome, the central bank said in a report that the financial institutions it oversees should monitor and control the climate-related risks they face.
The Fed said storms, floods, droughts and wildfires are among the "acute hazards" that could upend stable economic conditions. Given that those events are intensifying with climate change, U.S. banks should develop more information about how rising temperatures could affect the value of assets ranging from loans to beachfront properties, the report said.
"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," Fed Gov. Lael Brainard said in a statement.
Brainard, who heads the Fed’s financial stability committee, has emerged in recent days as a contender to be President-elect Joe Biden’s pick for Treasury secretary.
The central banking system itself is getting up to speed on climate risks by conducting research to better understand how global warming could affect the financial system. It’s engaging with the international regulatory community to develop ideas for addressing climate-related threats to the economy.
The Fed calls global warming a "growing economic and financial stability issue." Real estate assets serve as an example, the report said.
Residential and commercial properties will be increasingly threatened by extreme weather events including hurricanes and storm surges that result from sea-level rise. Those natural disasters are likely to drive down the value of at-risk properties — thwarting real estate loans and mortgage-backed securities, the report said.
"Given the uncertain timing and severity of future climate-related flooding and the associated opacity of asset exposures, investors in real-estate-linked assets may react abruptly to new information about a region’s exposure to climate-related financial risks," the report said. "A sharp repricing, in turn, could create incentives to fire sale such assets by leveraged financial and nonfinancial firms."
Enhanced climate-risk measurement and disclosure, the Fed argued, would help ensure that the financial system is accurately pricing climate risks, "thereby reducing the probability of sudden changes in asset prices."