The OCC’s View on Climate Risk Management

The OCC’s View on Climate Risk Management: An Update from Acting Comptroller Michael Hsu and Chief Climate Risk Officer Yue Chen   

It’s been nearly a year since The RMA Journal interviewed Acting U.S. Comptroller of the Currency Michael J. Hsu on the state of climate risk management in the financial industry and the OCC’s related efforts. The interview followed the release of the OCC’s Principles for Climate-Related Financial Risk Management for Large Banks proposal—and preceded similar proposals by other agencies. Recently, The Journal met with Hsu again, as well as OCC Chief Climate Risk Officer Dr. Yue (Nina) Chen, to discuss the intervening climate risk management progress that has been made, and the work yet to come. The following interview has been edited for length and clarity.  

The RMA Journal: Since our last interview, what have been the major developments in climate risk management and regulation?   

HSU: First of all, thanks so much for having me back, this time joined by Dr. Chen. There have been a number of changes and developments in climate risk management. On the regulatory front, there’s been greater convergence and coordination, especially domestically. The Federal Deposit Insurance Corporation (FDIC) and Federal Reserve followed the OCC’s lead on issuing climate risk principles and published similar guidance. There has always been good collaboration between the agencies but it has increased in quantity and quality the past year. Also, the Financial Stability Oversight Council stood up the Climate-Related Financial Risk Advisory Committee to serve as an interagency approach to climate financial risk. The committee is like an umbrella, with various work streams from the agencies working together. At the last Federal Financial Institutions Examination Council meeting, we shared climate risk management approaches and practices across agencies. There is a lot of collaboration, coordination, and convergence on this issue. With this topic, we all need to engage with each other a lot to avoid surprises, and to move in the right direction. 

While the OCC is currently focused on climate-related financial risks for large banks with more than $100 billion in total consolidated assets, I’ve also made it a point to meet with a lot of community banks. During our interactions, climate risk management comes up pretty much in every meeting. The only difference is whether it’s the first or second question they ask. We welcome that engagement even though it is not our focus. It’s been very helpful. We wanted to make sure that we are not just talking to community banks, but that we are going to where they and their communities are—where fears around climate change, its impacts, and policies in Washington are heightened. These visits are very important to us. We are going to continue engagement with financial institutions of all sizes.  

Meanwhile, at the OCC we further professionalized our climate risk management efforts. We officially established an Office of Climate Risk and hired Dr. Chen, who was previously the executive deputy superintendent of the Climate Division at the New York State Department of Financial Services, to head it. Through these efforts we are institutionalizing and increasing the profile of climate risk management and providing more resources—which helps improve our internal capacity and our processes.  

The RMA Journal: Can you describe what the chief climate risk officer role entails?  

HSU: I will let Dr. Chen field that question but first I will provide some context around her position. The topic of climate-related financial risk management is novel, complex, and politically tricky. That means we have to be especially credible if we’re going to be trusted to do the right thing in this space—credible with the banks, credible with scientists, and credible with the public. This is a very fraught topic. We want to do it right. We need a leader in the organization who knows the science, who knows finance, who knows supervision, and Dr. Chen is that person. She is the right leader in the organization to build that credibility.  

CHEN:  I feel very honored to have the opportunity to lead and direct the OCC’s activities related to climate-related financial risk. We are working in a very collaborative manner. There is a lot to learn and to continuously adapt to, for example: developing consistent strategies, policies, and guidance for our risk-based exams. The draft principles the OCC issued are the starting point of that. We also want to have consistent messaging on what this risk is, and what the OCC’s work is about. We need to have a very educated workforce to execute this work. From a regulatory perspective, we want to be able to understand, identify, and assess these risks just like we expect our regulated entities to do. Lastly, we want to be supportive of our regulated entities as they start considering climate-related financial risk management. This is a learning process for them and us. We have information we can share with them. We want to be on this learning journey together. 

The RMA Journal: The OCC’s operating plan for 2023 says at the largest banks examiners will monitor the development of climate-related financial risk frameworks and will engage with bank management to understand the challenges that banks face in this effort. How has that effort been going and what kind of feedback are you getting from the banks? What are you learning? 

CHEN: We’ve been observing that the large banks of $100 billion and larger are still in the early stage of implementing climate risk programs. During the past few months, we have been doing very in-depth discovery reviews of these programs. Early last year, we did range-of-practice reviews and got a lot of good information from the industry. We have noted that, since then, large banks have been making progress incorporating climate-related financial risk in their risk management frameworks and governance. But the level of progress among the largest banks still varies. 

Some large banks are developing project plans and organizing structures across the three lines of defense to be able to better identify and manage risk. Some are training both their board and senior management as well as staff, and building subject matter expertise internally. It is a new area and a lot of expertise is needed. There are also some large banks making progress toward including climate-related financial risk in their risk appetite statements. So far, most are observing qualitative risks. But there have been efforts toward quantitative metrics as well. Overall, many large banks are still in the early phase of understanding this potential risk. But we are seeing progress and tools being built and so on. As we learn more, we hope to share more information on leading practices with the banks. 

The RMA Journal: What are their biggest challenges in assessing climate-related financial risks?  

CHEN: The large banks are faced with limitations in terms of climate-related data—not just in the U.S. but internationally. Many are using external data and some supplement it with internal data. For example, with physical risk, it’s very challenging for banks to obtain very precise, location-specific data. They might know where the headquarters of their obligors are, but they don’t necessarily know where the relevant facilities are. That’s still a developing area, and we are seeing more data providers specializing in this space.  

Large banks with more mature programs have started to develop forward-looking scenarios to better understand how climate risk might impact them. But that creates another question in terms of the right time frame. Is it short term? Medium term? There are many modeling choices and many assumptions banks can make. In our discovery review, we’re trying to understand all of this. Large banks with less-mature programs are still developing their internal capacity and hiring, and trying to close the knowledge gap. 

The RMA Journal: What, if anything, has been surprising about the climate risk management journey for banks and regulators? 

HSU: Luckily, not much has surprised me—for two reasons primarily. First, this is a shared journey. Banks and regulators are doing this together in terms of learning what the risks are, how to think about the risks, and how to identify and measure them. That has resulted in a lot of engagement. It’s hard to have surprises when you’re constantly talking to each other. Meanwhile, on an interagency basis—domestically and internationally—there’s a lot of engagement. That’s healthy. It does take a commitment. But we’ve made that commitment and it helps to keep the surprises to a minimum. 

Where there has been what one may call a surprise is at the community bank level—in cases where there hasn’t been engagement. That’s part of the reason why we’re getting out there and talking to community banks. Because once you start engaging, the issue is a lot less scary. The community banks I’ve been talking to often say something like, “Okay, we have a better feel now for where this is going and what you’re trying to do. Your objectives are safety and soundness and risk management. We get that.” Without such engagement, there could be a lot more unanswered questions on this topic. We are trying to keep all banks informed and stay focused. 

The RMA Journal: The OCC has indicated that community banks will not be regulated regarding climate risk for some time. That being the case, what steps should community banks be taking at this time?  

HSU: What I tell every community banker is “use the time wisely.” They are going to have some time before we do examinations on these particular risk management issues since our focus is on large banks with more than $100 billion in total consolidated assets. I liken climate risk issues to learning a new language. Some of those risks everyone understands. But depending on where you are and your business model, each bank is different. Many community bankers say, “We’ve been dealing with weather-related risks for some time.” Which is true. But the severity, the frequency, the duration, the scope of the risks—those are new elements. The transition risk element—how shifts in policies, markets, and consumer preferences will affect bank credits—is also new. It’s not easy to go into that world without knowing the vocabulary of how to talk and think about those things. 

This period of time can be used to learn that vocabulary. Climate risk profiles can be particularly divergent for community banks. A community bank in the Midwest is going to have a very different climate risk profile than one on the Gulf Coast versus one on the West Coast. I get told all the time, “Don’t treat all bank community banks as one-size-fits-all. Please recognize that we’re different and don’t do trickle-down regulation.” I want to address climate risk the right way for community banks. We can do that best if they use this time to learn the climate risk language so that we can have an informed discussion in the future to say, “Okay, what are you doing? How are you thinking about things?” And they can say, “Here’s how.” That’s a much better conversation than if we show up in the future and the bank says, “What do you want me to do?” That’s a hard conversation to have unless there’s been some learning done and banks ask questions.  This is a journey we’re on together. This is not us versus them. 

The RMA Journal: How did it come about that the OCC was the first U.S. prudential regulator to release climate risk management principles?  

HSU: I made climate risk one of my top four priorities for the agency when I came here in May 2021. That was a result of thinking through the major threats to safeguarding trust in the banking system—the things that we have to marshal our resources for and focus time and attention on to get right. Acting on climate-related financial risks was one of those priorities. That drove several actions, including having the OCC join the Network for Greening the Financial System and appointing a chief climate risk officer. 

It’s significant that the other agency climate principle proposals are very similar. That’s because from day one, at the principal level down to the staff level, there has been a lot of coordination and collaboration. One thing we’ve heard from a lot of banks is “please stick together as regulators on this”. That request is well taken. It will help everybody, both banks and regulators, if there is a lot of coordination. We’ve endeavored to do that, and that helps explain how, content-wise, we are looking very similar.   

The RMA Journal: Comptroller Hsu, at the time the OCC principles were released, you suggested questions that boards should be asking their management teams regarding climate risk. Do you still stand by these questions? Would you add any? And if so, what would they be?  

HSU:  I absolutely stand by the questions. But there’s a slight tweak to one, which I will explain, considering the climate-related elements in the Inflation Reduction Act. But to take them in order, the first question to ask was, “What’s our overall exposure to climate?”  Obviously, that’s the main question that drives a lot of the work. The second question was, “Which counterparties or sectors and locales warrant heightened attention?” That’s kind of a subset of the first question, so that obviously warrants a lot of focus and attention. That’s also a keeper. The third question was about transition risk and requires a tweak. I posed, “What’s the exposure to something like a carbon tax?” What’s interesting is that Congress then passed the Inflation Reduction Act, whose effect will be the opposite of a carbon tax because of its incentives. It’s more carrots than sticks. The original question is still correct in terms of discussing transition risk. But now it’s more properly stated as “What’s our exposure to the changes that will result from the IRA being implemented?” That links well with another question, which was, “How can you seize opportunities from the climate transition?” There are obviously risks. That’s how The Risk Management Association and risk managers see the world. But with risk comes opportunity. Those who manage risks well will be able to navigate those opportunities better. It’s interesting that Congress has taken an approach which is more carrots than sticks. That might tie in, depending on the bank and its business models, with certain opportunities that banks can perceive.  

The last question was about vulnerability of data centers and critical operations.  We’ve seen a lot of events this past year where that’s kind of a live question. I think the questions as a whole are pretty solid. Ask us again next year. We’re hoping that as we go through our range-of-practice exercise, asking these questions really starts to bear fruit.  

The RMA Journal: You also said at that time that within a year, management teams hopefully should be able to answer these questions with greater accuracy and confidence. Are you seeing any evidence of that happening or not happening?  

HSU: We are seeing progress at the large banks in terms of developing the governance process and structure to better identify and understand climate-related financial risk. We’re also seeing increased confidence at large banks with more mature programs to develop processes to manage the risks—to go beyond just identifying them. But there’s still a lot of work to do. And integrating that work into business decisions is still a work in progress. 

The RMA Journal: What are the OCC’s goals regarding regulation and messaging about climate risk management at banks? What milestones might you have in coming months or years to indicate whether you are meeting your goals?   

HSU: The real goal boils down to safety and soundness. Can banks effectively risk-manage their exposure to climate? That may sound basic but it begs a lot of questions. For example, what exactly are the climate risks? We’ve had many conversations about physical risks and transition risks. Those are tricky to identify and to quantify—to get your arms around. The goal is to make this similar to what we do for every other risk in banking: interest rate risk, liquidity risk, market risk. So that it becomes an area where the practices and approaches, and what’s prudent, are well understood. And banks know what the expectations are and we know how to examine for that. That’s the ultimate goal, but it is going to take a while to get there. Luckily, there are a lot of very dedicated professionals at the OCC and in the industry focusing on that. 

The milestones are harder. We want to make sure there is progress. But it’s fair to say progress is not going to be monotonic and linear. That’s the nature of dealing with things that are novel and challenging. Sometimes you are going to see what seems like a lack of progress and then suddenly a lot of progress. That’s not unusual. What’s critical is that commitment is there, that engagement is there, that we are doing the work. We will be doing that and we expect the banks to be doing that.  

We are interested in the long-term success of what we’re trying to do. We do expect folks to hold us accountable; this is not a paper exercise. This is something that we seriously need to do. 

 

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