Climate Risk and Central Banks with Dr. Kevin Stiroh

What role do central banks play in addressing climate change? Listen to Jason Mitchell discuss with Dr. Kevin Stiroh, Resources for the Future and former Federal Reserve, about how to frame climate change as a financial risk at the systemic and institutional level, what’s at stake in this effort, and why it’s vital we continue to develop new macroprudential and microprudential frameworks addressing climate risk.

Recording date: 05 November 2025

Dr. Kevin Stiroh

Dr. Kevin Stiroh is a Senior Fellow at Resources for the Future where he is the director of the Climate-related Financial and Macroeconomic Risk Initiative, a research collaboration between the Salata Institute at Harvard University and Resources for the Future. He was a senior advisor in the Division of Supervision and Regulation at the Board of Governors of the Federal Reserve System, where he designed and led the Fed’s microprudential approach to the financial risks of climate change. He also served as Co-Chair of the Basel Committee on Banking Supervision’s Task Force on Climate-Related Financial Risks. Prior to that, Kevin served as executive vice president and head of the Supervision Group at the Federal Reserve Bank of New York and on the New York Fed’s Executive Committee. He was also Co-Head of the Market Operations, Monitoring, and Analysis team, where he led work on the implementation of monetary policy, financial stability analysis, and discount window operations.

Episode Transcript

Note: This transcription was generated using a combination of speech recognition software and human transcribers and may contain errors. As a part of this process, this transcript has also been edited for clarity.

Jason Mitchell:

I am Jason Mitchell, head of Responsible Investment Research at Man Group. You're listening to A Sustainable Future, a podcast about what we're doing today to build a more sustainable world tomorrow.

Hi, everyone. Welcome back to the podcast. And I hope everyone is doing well. So, one of the many debates in modern finance asks this question: what role should central banks and financial supervisors play in addressing climate change? And I think more importantly, how should they adapt their mandates, tools, and frameworks to a risk that's simultaneously global, structural, and time-varying. In other words, something that's unfolding over decades but already materialising in the real economy today. In fact, I think back to something Mark Carney said, which is that once climate change becomes a defining issue for financial stability, it may already be too late, which basically captures the mismatch between climate timelines and financial supervision timelines.

Now, I've already done earlier podcast episodes with the Bank of England and Deutsche Bundesbank, looking more at the macroprudential issues. This one, however, tackles the microprudential side. In fact, if there's one single takeaway, it's that diminishing regulatory pressures and weaker investor demand have essentially kicked off a natural experiment around sound risk management, particularly for the banking sector. It's why it's great to have Dr. Kevin Stiroh, a veteran climate policymaker, who sits at the intersection of financial stability, supervision, and the accelerating realities of climate risk, on the podcast. We talk about how to frame climate change as a financial risk at the systemic and institutional level, what's at stake in this effort, and why it's vital we continue to develop new macroprudential and microprudential frameworks addressing climate risk. We also dig into the evolving toolkit of climate supervision, scenario analysis, prudential expectations, capital frameworks, and the role of international coordination. We explore how supervisors think about chronic versus acute climate risks, what materiality really means in a prudential context, and how the regulatory landscape is changing as climate risk becomes a core part of financial stability planning.

Kevin is a senior fellow at Resources for the Future, where he's the director of the Climate-related Financial and Macroeconomic Risk Initiative, a research collaboration between the Salata Institute at Harvard University and Resources for the Future. He was a senior advisor in the Division of Supervision and Regulation at the Board of Governors of the Federal Reserve System, where he designed and led the Fed's microprudential approach to the financial risks of climate change. He also served as co-chair of the Basel Committee on Banking Supervision's Task Force on Climate-related Financial Risks. Prior to that, Kevin served as executive vice president and head of the Supervision Group at the Federal Reserve Bank of New York and on the New York Fed's executive committee. He was also co-head of the Market Operations, Monitoring and Analysis team, where he led work on the implementation of monetary policy, financial stability analysis, and discount window operations.

Welcome to the podcast, Dr. Kevin Stiroh. It's great to have you here. And thank you for taking the time today.

Kevin Stiroh:

Hi, Jason. Thanks for having me. I've enjoyed your podcast for a long time, and it's really nice to participate.

Jason Mitchell:

Oh, that's great to hear. I'm super excited about this. So, Kevin, let's start out with some scene setting first. You've talked about how central banks are within their mandate to consider physical and transition risks and the implications on the financial system. You've said specifically that "Anything that can impact the real economy should be understood and should be part of the risk monitoring." So, talk about why climate change is relevant first for central banks and supervisors. And I think more to the point, what do you say to those who believe that central banks don't have a role in this?

Kevin Stiroh:

The mandate is a great place to start. Central banks typically have many responsibilities, including those related to monetary policy, bank supervision, and financial stability. And I think that climate change is relevant for each of those responsibilities. Some central banks also have secondary mandates, like supporting the economic policies of the government around things like growth or competitiveness or a green transition. So that opens additional links to climate change.

My point of departure is that any policy or activity by a central bank or supervisory authority needs to be firmly embedded in its statutory mandates and responsibilities, whatever they may be. So, I'll drill down on bank supervision as an example, because that's been my focus. In general, bank supervisors expect supervised firms to effectively manage all of their material risks, whether that's from a business cycle, a cyber event, or a climate-related shock. That's the core goal of supervision because it allows banks to continue to provide their critical financial services through a wide range of economic and financial conditions.

When thinking about climate change, it's useful to think of the impact not as a new risk for a bank, but rather as a driver of existing risks that are part of the supervisor's existing responsibilities. What I mean by that is that physical and transition risks from climate change can impact very traditional banking risks, like credit risk or market risk or operational risk. For example, the increased risk of a wildfire could change the probability of default of a mortgage. A government policy shift could cause volatility in the value of a security that's held on the bank's balance sheet. Flooding could disrupt a bank's branch network. And banks and supervisors always manage risks like that. The challenge is that these risks are growing and they have distinctive attributes that likely require additional focus and expertise from banks and supervisors. These risks are likely to be wide-reaching and secular rather than narrow and cyclical. These risks are highly uncertain in terms of the timing and the impact across regions and sectors in terms of who ultimately bears the losses.

And third, the future's unlikely to look like the past. So existing approaches are likely insufficient and will need new tools, new data, and new expertise. All of that makes the strong conceptual case for why banks and bank supervisors should be concerned with the financial risks of climate change within their traditional safety and soundness mandate. And the same logic will apply for a central bank's financial stability or monetary policy responsibilities. So, I think you need to start with the mandate and see where the analysis takes you. If climate-related risk drivers can materially impact the real economy, the financial sector, or supervised banks, then it is relevant for a central bank or supervisory authority, even within the most traditional sets of mandates.

Jason Mitchell:

That's great. That's a lot to chew on. But for a second, let's start with what's at stake here. In a keynote speech last month, Frank Elderson, a member on the ECB's Executive Board, stated that "In the next five years, extreme weather events could put up to 5% of euro area economic output at risk, which would be a shock comparable to the great financial crisis." What do you make of this assessment? Is this a credible baseline scenario that supervisors and banks should be planning for, or does it represent a tail risk scenario designed to stress test preparedness? And maybe more importantly, how do you think this should shape the urgency and nature of supervisory action today?

Kevin Stiroh:

So, I think the evidence is clear and growing that climate change is impacting the real economy and the financial sector today. The speech that you mentioned from Frank gives lots of good examples of the growing impact of climate change. And let me add a few others. There's a well-known time series of Billion-Dollar Disasters in the US that used to be produced by NOAA, and that shows this general upward trend. That reflects a lot of factors, increased development in high-risk areas, rising rebuilding costs, and more extreme climate events. So, Climate change is part of that.

The Swiss Re estimates that insured losses are growing 5 to 7% per year. And in recent years, that was primarily due to secondary perils like severe convective storms. Again, not all of that is climate change, but it's part of it.

And then we have specific examples in the US, like the wildfire in California earlier this year and the hurricanes in North Carolina last year. The total cost of Hurricane Helene is close to $80 billion. Hurricane Milton, over $30 billion. Estimates around the LA wildfire are in the $100 billion range. Again, climate change isn't the only cause of those, but it makes events like that more likely.

So, to me, that all points towards the need for banks to build robust risk management systems and approaches to understand and manage these risks. And I think it's important to emphasise that you don't need to make the claim that climate change is the only driver of these risks, but rather that it is a meaningful contributor and operates in new and distinctive ways that warrant additional attention.

Jason Mitchell:

Yeah. It's a really interesting point, by the way, on the NOAA data set. And I note that a firm called Climate Central with a number of the ex-NOAA people will be continuing that data set, which is good to know. But how should we frame climate change as a financial risk? And I mean that both at the systemic and at the institutional level. You've talked about how climate change is a global, structural, and kind of foreseeable problem and risk. But does that mean that central banks conceptualise it as a systemic risk? Or does it also warrant attention specifically at a microprudential concern for individual bank safety and soundness? I guess what I'm asking is, how does addressing climate differ from traditional financial stability and prudential challenges, especially when the risk is both idiosyncratic and systemic?

Kevin Stiroh:

It's a good question, and let's do each perspective in turn. I'll start with the microprudential perspective, which is the supervision and regulation of individual banks that I've been talking about. And supervisors in the US and in other jurisdictions have a wide range of risk management tools, regulations, guidance to ensure that banks operate in a safe and sound manner. This includes things like how they interact with their board, what policies do they have in place, what information systems do they use to measure and manage risks. Given the distinctive attributes of climate change that I talked about earlier, it seems reasonable to have additional focus related to those climate-related risk drivers. And I think there is a pretty compelling case for why the distinctive attributes related to climate change cause banks to manage risks differently and cause supervisors to oversee them differently. So then the question is really one about materiality, one about prioritisation, and where do you put these risks on a complex board of potential risks to banks? So, that's the microprudential perspective.

Let me now turn to the macroprudential or the systemic perspective, where central banks worry about the financial system as a whole. And this is actually, I think, a much broader question than just climate change, and there's been a lot of work on what financial stability or macroprudential supervision means since the financial crisis in 2008. There've been new models, surveillance frameworks, institutional arrangements to try to understand these types of macroprudential risks. And for me, this is really about amplifiers and feedback effects that turn small shocks into big impacts. It could be about correlated risks that impact multiple parts of the financial system at the same time. And it includes uncertainty about the transmission mechanisms for how risks, how different types of shocks can be transmitted across sectors, potentially in unexpected ways, to redistribute the risk.

And climate change has the potential to impact all of those types of macroprudential amplifiers. There's good research around sequential and compound risks that can amplify the impact of a climate shock. More extreme weather events can impact multiple regions and change correlations of losses across geographies. Investors could change their view in abrupt ways that lead to quick repricing of financial assets. And we see lots of good work about how risks flow across the financial system from banks to insurers and reinsurers, securitized products, et cetera. And all of that is very hard to work out ex ante and good reasons to do more work to understand these potential effects.

Jason Mitchell:

I tend to think of the microprudential and macroprudential areas as not just discrete but separate in some ways. So, I guess from your experience, given the interrelatedness of climate change as a risk across those, how do those two efforts tend to work together and inform each other?

Kevin Stiroh:

I think the macroprudential perspective necessarily builds on the microprudential understanding of individual institutions, of individual sectors, and then asks what are the different mechanisms that those individual shocks can accumulate in ways that can have a broader impact on the financial system, in ways that spill over and have feedback effects to other parts of the system. And it's really that transfer of risk across and throughout the financial system that we worry about. The good example from the financial crisis in 2008 was the way that house price changes led to disruptions of securitized products and ultimately led to concerns about the solvency of large financial institutions.

Jason Mitchell:

Interesting. Really, really interesting. One of the big challenges of climate change is that climate risks manifest over decades. It's well beyond normal risk horizons, whether for macroprudential policy or individual bank supervision. How can both macroprudential frameworks and microprudential supervision internalise these long-term uncertain risks, specifically without undermining short-term financial stability objectives? In other words, how do we reconcile the tension between short-term price stability and bank solvency horizons, which typically look out maybe one economic cycle, maybe less, but that against climate risk modelling that requires a 30-year-plus outlook?

Kevin Stiroh:

Agree. This time horizon question has been central to the discussions about the impact of climate risk and the implications for central banks and for supervisory authorities. You're obviously right that climate risks may manifest over decades, but as we discussed, we're also seeing the impacts today in both physical and transition risks. So, in my view, from both a microprudential and a macroprudential perspective, the approach needs to focus on promoting the resilience and the robustness to this uncertain future.

There's massive uncertainty about climate change itself, about what the ultimate impact will be economically, how those impacts and potential losses will be allocated across the financial system. We'll see behaviour change, policy will change, that financial sector will adapt. So, prudent risk management suggests that financial firms and their supervisors should work to build out approaches that are robust to this broad range of future outcomes. It's not clear to me that firms should be actively managing today against any particular type of shock that may be realised in coming decades. Rather, I think firms should be building out business models and risk management strategies that have the highest probability to be resilient against a plausible range of future outcomes, including these potentially extreme ones. That's not an easy task, but it seems like the necessary task. We've heard banks talk about the difficulty, the challenges it is to incorporate that type of uncertainty into their business-as-usual risk management processes. So, that's the challenge for the financial sector.

Jason Mitchell:

How have you seen this tragedy-of-the-horizons debate evolve over the last decade in the prudential risk space? I think about it in the context of asset management, and there's been an obvious focus on long-term risks, typically through stress testing portfolios. At the same time, we're seeing weather impacts already occurring in the short-term. So, I guess I'm wondering how you think about bridging these two points temporally, the long-term and the short-term, through more informed asset allocation.

Kevin Stiroh:

I think you're getting at what I think is a deeper question about what is really the role of finance in all of this. And corporations, including financial firms, have responsibilities to multiple stakeholders, to their customers, to their shareholders, to their employees. But it's not necessarily a responsibility to internalise this long-term fundamental carbon externality that's driving climate change. That at its heart is the responsibility of the elected officials. So, from a purely microprudential perspective, it's not clear to me that it is the responsibility of individual firms to solve that problem. Rather, their job is to ensure that they can continue to serve their clients, to serve their customers, to work with their stakeholders, to ensure that they're resilient to the broad impacts of climate change.

Jason Mitchell:

Interesting. So, policy is obviously a super important area. But, I mean, aside from that, what tools and frameworks do you see helping regulators effectively pull the future forward to make long-term climate risks actionable within at least today's prudential and macrofinancial policy horizons?

Kevin Stiroh:

So, central banks, supervisory authorities, they necessarily have to take this type of forward-looking perspective. That's really a core feature of what effective risk management does, whether that's at a bank or at a supervisory authority. Monetary policy is necessarily forward-looking. So, that's one reason I think why stress testing and scenario analysis have become so popular in the last 15 years or so since the financial crisis. And I think that's particularly true in this type of context where the past is likely to be a poor predictor of the future in terms of the shocks that banks might face. So, from my perspective, I'm less worried about encouraging banks to manage any particular risk, but rather to think about how they build business models that are resilient to the broad range of uncertainty.

That said, I think it is a blurry line, and financial markets have a way of pulling forward risks into current asset prices. That's what they do. So banks need to continue to develop these forward-looking tools and incorporate them into their current business decisions in terms of how they work with their clients, how they make strategic decisions, how they manage risks today.

I think at the same time, there are some good arguments, primarily from a macroprudential perspective, that are designed to try to prevent the future risks from accumulating. So, for example, there are academic and policy papers arguing that one could use the countercyclical capital buffer as a tool to prevent the buildup of these types of risks. And I think those macroprudential tools are worth investigating. But again, as always, in the context of what is the particular mandate of the central bank or supervisory authority, and with the recognition of deep uncertainty and the potential for unintended consequences.

Jason Mitchell:

You mentioned stress tests earlier, which a number of central banks have started using, but the results often show minimal or limited effects, which kind of confounds intuition. I don't think asset management, by the way, is any different. It's seen the same reaction and criticism in terms of the minimal impact to portfolio value, largely because of assumptions around discount rates. But how do you reconcile these findings?

Kevin Stiroh:

It's a good question, and there has been a lot of really excellent work done across central banks on this, the Bank of England, the ECB, the Fed, the Bank of Japan, Monetary Authority of Singapore, the OSFI in Canada, and many others. And you're right that most of them find the impact to be some form of limited or manageable. In addition, there's a large and growing body of academic work that looks at the impact of climate change on the banking system that also typically finds a limited impact and concludes that it's difficult to quantify what the historical impact of climate change has been on financial firms. So, that's both a forward-looking perspective and a historical perspective.

So, why is that? Why is it that these studies tend to not find such a large impact? One hypothesis, and I think there are good reasons to believe this, is that these studies might be systematically understating the future impact of climate change. So, let me give a couple examples related to how these large-scale scenario analysis exercises are done. Typically, the scenarios are orderly scenarios that are not too stressful. There aren't these big climate tipping points. There aren't these massive breakdowns in financial markets that some fear. These studies typically look at and assess only a portion of a bank's activities or bank's balance sheets. For example, they tend to focus on real estate lending or commercial lending and not a broader set of assets or revenue streams. These studies typically look at large diversified banks who are probably best positioned to withstand the impacts of a climate-related shock, rather than small concentrated banks in a specific geographic region who are likely to be most exposed to those types of physical risks.

And finally, these studies typically don't fully include the potential impact of indirect effects or of compound risks. And what I mean by that is, indirect effects would be not just the impact, say, of a hurricane that destroys a home for which a bank has a mortgage but also what happens to the infrastructure? What happens in terms of population migration? What happens in terms of local economic activity and tax revenues, these effects that impact the local economic activity? Or compound risks. The impact of a hurricane in the midst of a recession is likely to be very different than the impact of a hurricane when house prices are high and the banking system is particularly healthy.

So, those are reasons to think that maybe these forward-looking studies haven't gotten far enough out in the tail and haven't really looked at the most extreme outcomes. But on the other side, I think there are some arguments that push back. So, we know that banks aren't passive players here. They're actively managing their risk in a dynamic sense. So they will continue to evolve. And of course, the economy, broadly defined, will adapt as these shocks occur or as relative prices change. So, the general point is that the future's unlikely to look like the past. So it's really difficult to be confident in these types of estimates.

Jason Mitchell:

Absolutely. Climate risk is obviously a global phenomenon, but financial regulation is largely a national one. How do you see central banks and supervisors ensuring consistent approaches to climate risk management across all these different jurisdictions, especially given differences in mandates, political environments, data quality, et cetera?

Kevin Stiroh:

Yeah. I think the earlier framing that prudential supervisors should care about any shock that has the potential to impact the financial system or the real economy is the right place to start. So, as an example, let's start with the Basel Committee on Banking Supervision, which is the primary global standard-setting body for the prudential regulation of banks. So, what that means is that it is designed to ensure that banks operate in a safe and sound way that allows them to continue to provide the critical financial services. And the Basel Committee defined its work around the financial risks of climate change as taking a "holistic approach" to addressing these risks with the purpose of enhancing financial stability. So, that's a very traditional perspective. It focused on the risk management approaches of supervisors and banks and not on broader objectives like promoting a transition to a low-carbon economy.

Within that context, the question of consistency has been central to the work of the Basel Committee generally. In fact, I think one of the most common requests from the financial sector is the desire for consistency and harmonisation in international supervisory and regulatory practises. That reduces complexity. It reduces regulatory burden. And it increases the efficiency of banking. So, that's what these types of international groups are designed to achieve.

Jason Mitchell:

Yeah. That's really helpful. In fact, I actually want to come back to the Basel Committee as well as NGFS. But before that, I noticed that Resources for the Future recently launched the Climate-related Financial and Macroeconomic Risk Initiative with the Salata Institute for Climate and Sustainability at Harvard. This is really interesting. Talk about the purpose of this, I guess, multidisciplinary initiative. What gap does it fill? And why is something like this needed now?

Kevin Stiroh:

Yeah, that's right. So, we launched this new initiative in September between Resources for the Future and the Salata Institute. And I think the gap that it fills is really to create a network in the US that will bring together the expertise from multiple perspectives. So it will include participants from economics and finance, from the private sector, the scientific community, from the nonprofit world, in order to build a deeper understanding of climate-related financial and macroeconomic risks in order to promote stronger policy responses.

This initiative has three specific mutually reinforcing goals. One, to deepen understanding of these risks. Two, to promote better policy responses. And three, to grow the research community to ensure there's sufficient capacity going forward. And we'll do that both through fundamental research and policy development.

You mentioned the multidisciplinary angle, and I think that is absolutely critical. In my experience, you can get a deeper understanding, you can get better insights about complex problems when you bring together those multiple perspectives. We know that the academic world, the scientific world, the financial sector, the official sector all have slightly different objectives. They use different tools. They face different constraints and trade-offs. And bringing those together will inform the work and allow us to build and offer better, more robust, more durable solutions.

Jason Mitchell:

Yeah, really exciting. I look forward to some of the work. I know the Salata Institute's been around for two or three years, and I've actually read some of the insurance adaptation-related work coming out of it. So good luck with that. But I also wanted to touch on a recent paper you co-authored called Climate Change and the Role of Regulatory Capital: A Stylized Framework for Policy Assessment. You write that "While climate change could potentially impact the regulatory capital regime in several ways, an internally coherent approach requires a strong link between specific assumptions about how financial risks may manifest as bank losses and what objectives regulators are pursuing," which is really interesting. But I guess, can you lift the text off the paper and describe your thesis? What are you kind of solving for here through this framework?

Kevin Stiroh:

So, in the last few years, there's been a lot of interest in whether one specific part of the supervisory and regulatory regime, particularly the capital framework, could or should be modified to reflect and incorporate the financial risks of climate change. So, this is a joint paper with my former colleagues, Michael Holscher, David Ignell, and Morgan Lewis. And we tried to present framework that would allow us to do that.

We begin with this traditional view that bank capital is there to absorb losses, and that will increase the resilience of the bank. It's very traditional perspective. And we make two primary points. The first is that any discussion about changing the regulatory capital regime needs to have a clear view about how climate change may impact future bank losses. And what I mean by that is, do you think that potential losses for a bank will increase on average or will they become more volatile? And that distinction between the mean and the variance is critical from a capital perspective, because if losses are expected to increase, that's something you can manage with tools like ex ante pricing or reserving for loan losses. But if the losses are becoming more unpredictable so that unexpected losses are likely to rise, then that suggests a role for regulatory capital. So, the key question is whether or not physical and transition risks will make losses more volatile in the future. So, that's an open question. The paper doesn't try to answer that but sets that out as the key question in discussions of regulatory capital.

Jason Mitchell:

That sounds like a cliffhanger, basically.

Kevin Stiroh:

Yeah. Exactly. So, the second point that we make is that you have to be very precise about what problem you're trying to solve. What is the objective? Because the regulatory capital framework, it's really complicated. It's got many moving parts. It's got minimum requirements, different types of buffers, different types of asset-specific assessments around the relative risks of different types of assets. And each of those is designed to solve a different problem. And you need to be clear about which part of the regulatory capital regime you want to look at in the context of the impact of climate change.

Jason Mitchell:

So, maybe leaving that paper, but staying on this topic, which, just given your experience as co-chair of the Task Force on Climate-related Financial Risks of the Basel Committee, what functionally could that look like in a Basel context in terms of establishing new levels of reserve capital for the banking system? Capital reserves are obviously intended to absorb expected and unexpected losses. But are there any lessons we could take from the insurance sector in terms of insuring, managing, and provisioning against unexpected climate-related losses?

Kevin Stiroh:

So, the key question here is whether or not you view potential losses for an individual bank as changing in the future. Said differently, do you think this whole distribution of potential losses could change in response to physical and transition risks? And that's going to reflect a number of factors. There are good reasons to think that climate-related risks could lead to unexpected losses and more variable losses going forward. This would be the uncertainty that we talked about, unpredictability around policy changes or technology changes, financial amplifiers and feedback loops, compound risks. There's lots of good reasons to think that that could happen. But ultimately, that's going to be an empirical question that policymakers will need to make a judgement about before there's any changes in the regulatory capital structure. Linking back to what we talked about before, the challenge is that these forward-looking scenario analysis and stress tests don't provide compelling evidence that that's the case.

In terms of insurance, I think the banking system is learning a lot from the insurance and the reinsurance sectors, given that they have focused historically on these types of risks. So, as a few examples, we see banks building capacity around natural catastrophe models, which were largely developed in the insurance sector. We see the banking system and the bank supervisors developing these new tools like stress testing and scenario analysis to better understand these risks. And we see the insurance sector actively changing in real time as they work to manage the financial risks of climate change.

There's a lot of academic work, for example, that shows the insurance sector, particularly in the US, responding in very predictable ways in terms of the availability and the pricing of insurance. And I know you've talked about insurance quite a bit on your podcast with some real experts. So, just to quickly summarise what the academic research shows, that in higher risk areas, we see higher premiums, increased delinquencies, increased prepayments, lower renewal rates, and reduced coverage. All of that ultimately impacts who bears the risks of climate change. For example, if under-insurance increases, households and banks become more exposed to physical risks.

Jason Mitchell:

It does remind me of the recent episode I had with Dr. Carolyn Kousky on the subject. To stay on Basel, I found it interesting. In June, the Basel Committee published a framework for disclosing climate-related financial risks. Now, originally in 2023, the disclosures were supposed to be a requirement under Basel's prudential and capital rules. Instead, it now looks like they're voluntary. What would proposals that have teeth, I guess, look like that link climate risk to capital? For instance, an obvious one would be to adjust for risk-weighted assets based on environmental impact.

Kevin Stiroh:

Yeah. So, building on a couple of the ideas that we discussed earlier, I just want to be really careful here about the language and distinguish the impact of climate change on a bank from the bank's impact on climate change or environmental impact.

Jason Mitchell:

You're absolutely right. Thank you for clarifying that.

Kevin Stiroh:

Yeah. So, on one hand, adjusting risk weights to reflect differences in the risk to the bank seems entirely appropriate. It's within the traditional approach of bank supervision and regulation. And that's ultimately an empirical question. Do these types of climate risk drivers change the relative risk of different assets? On the other hand, do institutional arrangements like guarantees that might come from a multilateral development bank change the relative risk of different assets? If the answer is yes, then those types of effects should be accounted for in any well-calibrated risk-based capital regime. And that's generally true. That's true for any emerging or evolving risk. And the challenge is incorporating those new risks into this really complex machinery around regulatory capital.

Jason Mitchell:

I wanted to finish up with a few more questions. But the first one is, it's something else, it's another point that Frank Elderson had raised, Frank on the ECB executive board, but he had lauded initially the commitments of the Net-Zero Banking Alliance back in 2023. It's interesting. In the past year, we've seen the dismantling of both the Net-Zero Insurance Alliance and the Net-Zero Banking Alliance. If these alliances were, at least initially, seen as reinforcing resilience to climate risk, what do you think their dissolution now represents?

Kevin Stiroh:

I think these recent changes in the last few years, including but also broader than what's happened with the Net-Zero Banking Alliance, constitute what is going to be a very informative test case for how the financial system deals with the financial risks of climate change. So, I think we see this tension right now, particularly in the US. As we've discussed, physical risks are rising, and there's a strong prudential case for supervision. But on the other hand, the financial sector seems to be pulling back.

For example, as you said, financial firms are exiting industry alliances like the NZBA. They're talking less about climate change. We all see supervisors and regulators doing less. So, the Basel Committee, as you mentioned, shifted to this voluntary disclosure regime. They've somewhat narrowed the work plan around climate-related financial risks. In the US, the US federal banking regulators recently withdrew their risk management guidance. They exited the network for greening the financial system earlier in the year. So, there's this change in the posture within the financial system. And I think this is really a natural experiment now.

So, why did the financial system focus so much on climate change, say, in the years 2020 to 2023? I think it was some combination of, one, supervisor and regulatory pressure, two, investors were demanding it, and three, sound risk management, sound business decisions. So, what we see now is that supervisory and regulatory and investor pressures are gone, or at least they've dissipated massively. So we'll see going forward if banks are making investments, continue to make investments in monitoring and managing climate-related risks. Is that a good business decision? And I think we'll see them acting in that way for business purposes.

In my view, understanding climate risks and opportunities will turn out to be a competitive advantage, and we'll see banks do more, but probably talk about it less. The economists identified this shift from greenwashing to greenhushing. But I think we'll see banks continue to invest in the data and the models and the people that are needed to understand these risks. I think we'll continue to see banks working with their clients to find opportunities to help them manage the risks and transition as the economy transitions to a different carbon footprint.

Jason Mitchell:

As we move through this, as you call it, natural experiment, what kind of metrics and ratios do you think are key to watch, like the Energy Supply Banking Ratio or green loan book exposure? What balance sheet proxies do you watch for as, I guess, a less-formal indication of continuing commitment among the banks in particular?

Kevin Stiroh:

I think that's a hard question but an important one. Let's contrast that with the insurance sector where we see these clear trends in terms of the pricing and the availability of insurance in certain regions. So, the question from my perspective is, will we see those kinds of changes in the banking system? Will climate-related risks be priced in the borrowing costs in certain regions? Will we see banks imposing balance sheet limits? Will they make strategic shifts in how they think about where and how they provide credit? How will banks work with their clients to help them transition as the economy changes?

Unfortunately, it's really challenging to see those types of risk management steps in any publicly available data. I think some of the balance sheet metrics that you mentioned can be useful, but not always the best proxy for the risk that the bank faces. And you hear banks talking increasingly focused on the fact that they might see their financed emissions rise in the short term as they work with firms to help them transition their own operations. So, I think those metrics are really challenging and not necessarily the clear indicator of how banks are responding from a risk management perspective.

Jason Mitchell:

Yeah. Interesting. How aligned do you think global regulators are today on integrating climate risk into supervision? We've seen some pretty divergent regulatory approaches, from the ECB's detailed climate guidance to the US's obviously more cautious stance. How are organisations like NGFS cultivating convergence on what good climate supervision looks like despite all these differing mandates and political economies?

Kevin Stiroh:

Yeah. We definitely see divergence right now. As I mentioned, the US has pulled back, but other central banks continue to focus on promoting good risk management around these climate risk drivers. You mentioned the NGFS. They have almost 150 members across 91 countries. That is a voluntary coalition of central banks, of bank supervisors, and I think they've done a great job in the supervision space to consider how effective supervision can incorporate climate-related risk drivers.

They've really focused on this from the beginning. All the way back in 2017, they were thinking about the role of supervision. And they've played an important role in identifying relevant issues. They have guides, practical guides for supervisors, thinking about transition plans, thinking about both climate and nature-related risks, legal risks, et cetera. And I think that is particularly valuable for smaller jurisdictions, which might not have the scale to develop these frameworks independently.

The challenge is that the NGFS is not a formal standard-setting body. Each jurisdiction needs to decide how to incorporate climate risks into its own supervisory and regulatory regimes. Nonetheless, that seems like a very valuable contribution to continue to develop these type of practical guides for a broad range of supervisory authorities. And then over time, best practises can emerge, which can be codified into standards in the future.

Jason Mitchell:

Yeah. I wanted to try and close the loop with this conversation around NGFS and the earlier discussion around climate modelling. Climate scenario analysis has been one of the NGFS's flagship tools, but these scenarios tend to stretch 30 or 50 years into the future. Critics would say that they tend to ignore nonlinear effects like climate tipping points and sometimes often rely on overly simplistic assumptions about economic activity and transition risks. How can supervisors make such long-horizon exercises relevant to near-term prudential decisions? How do you see the NGFS helping supervisors specifically incorporate those tail risks and tipping points into stress testing and risk modelling?

Kevin Stiroh:

The NGFS, these scenarios are widely used, and I think they've emerged as an important part of the toolkit within the financial sector. So, let me try and answer your question from a couple different perspectives. First, from the producer's perspective, the NGFS who produces these scenarios. As you say, they've started with long-term scenarios, and they were used by central banks, including the Bank of England, the ECB, and the Fed. Earlier this year, the NGFS also introduced short-term scenarios that were explicitly designed to be more useful for monetary policy, prudential policy considerations. And these scenarios include extreme weather events, climate policies, transition risks, combination scenarios, et cetera. So, these will be a useful complement to the longer-term scenarios, and they might be more appropriate for specific questions related to monetary policy and risk management.

The second perspective is from the users of the scenarios, the supervisory authorities or the financial firms that utilise them for their own risk management purposes. And here, I think it's important to start with the objective and why are you using the scenario. What question are you answering? The Basel Committee put out a paper on this in 2024 that considered a wide range of different objectives for scenarios.

So, let me give a very practical example. The exercise that the Federal Reserve completed in 2024 was focused on two very specific objectives, which impacted all of the design decisions around it. So, those objectives were to learn about banks' risk management practises, and second, to enhance the ability of large banking organisations to measure, monitor, and manage risks. So, that meant that there were certain features of these scenarios that were either more or less important for the specific question being asked.

So, if that's your question, if that's your goal to understand what banks are doing, that very long time horizon is less important because you're asking how banks are managing or modelling the risks over the relevant shorter-term horizons. You might worry less about the precise details of any particular scenario because you want to understand how banks are using the scenarios rather than any specific outcome, any specific numeric result that comes from that scenario.

I think there will be a continued iteration between the producers of the scenarios by groups like the NGFS and the users of the scenarios, like supervisors and banks. And that's really healthy progress. Capacity will continue to build to solve real-world use cases using these types of forward-looking scenarios.

Jason Mitchell:

Great, great. So, it's been fascinating to discuss how to frame climate change as a financial risk at the systemic and institutional level, what's at stake there and why it's vital we continue to develop new macroprudential and microprudential frameworks that address climate risk. So, I'd really like to thank you for your time and insights.

I'm Jason Mitchell, head of Responsible Investment Research at Man Group, here today with Dr. Kevin Stiroh, senior fellow at Resources for the Future. Many thanks for joining us on A Sustainable Future. And I hope you'll join us on our next podcast episode. Kevin, thank you so much for your time today. This has been super interesting.

Kevin Stiroh:

Thanks very much. I really enjoyed the discussion.

Jason Mitchell:

I am Jason Mitchell. Thanks for joining us. Special thanks to our guests and, of course, everyone that helped produce this show. To check out more episodes of this podcast, please visit us at man.com/ri-podcast.