Banking's Climate Conundrum

Abstract

Over the past decade, a consensus has emerged among academics and policy makers that climate change could threaten the stability of banks, insurers, and the broader financial system. In response, regulators from around the world have begun implementing policies to mitigate emerging climate risks in the financial sector. The United States, however, lags significantly behind other countries in addressing such risks. This article argues that the United States' sluggishness in responding to climate‐related financial risk is problematic because the U.S. banking system is uniquely susceptible to climate change. The United States' vulnerability stems, in part, from a little‐known statutory provision that prohibits U.S. regulators from relying on external credit ratings in bank capital requirements. Because of this deviation from internationally accepted capital standards, when a credit rating agency downgrades a “dirty” company, U.S. banks that lend to that company need not compensate by maintaining a bigger capital cushion. Over time, this dynamic will likely incentivize “dirty” companies to borrow more from U.S. banks, intensifying the U.S. banking system's exposure to climate risks. This article contends that the United States must overcome this unusual weakness by taking bold steps to safeguard the domestic financial system from the climate crisis.