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Financial stability matters when it comes to tackling climate change

Climate change is one of the greatest threats facing humanity. As such, the House Subcommittee on Investor Protection Entrepreneurship and Capital Markets is leading the discussion with a hearing today. The panel rightfully realizes that with a changing climate comes a completely new dimension of risk to the financial industry. One must only look toward the recent catastrophic winter storm damages to know that now is the time for financial regulators to proactively deal with this threat.

While federal agencies must maintain appropriate boundaries between environmental policy and financial regulation, they should identify and mitigate such growing risk to the financial system from environmental threats. Volatile weather, rising sea levels, and often intensifying natural disasters impact financial institutions from their exposures to affected households and businesses as well as the collateral damage.

If banks have failed to manage and prepare for such climate threats, the resulting losses could lead to a broader contraction in credit availability, hurting the already fragile economy. The goal of financial regulation and oversight should be to prevent this from happening in the first place. The administration, the Federal Reserve, and the Financial Stability Oversight Council, should focus on the following to achieve this goal.

Regulators, institutions, and investors cannot mitigate threats that are not transparent. A clear global approach to corporate sustainability reporting must be at the top of the climate checklist for the administration. Leaders must address the woefully insufficient corporate reporting as it relates to climate change and related risk to companies. We are in desperate need of a better disclosure framework which could properly disclose material climate trends and corporate decisions to mitigate threats.

Our systemic risk agencies must work with their global counterparts to accurately measure emerging financial threats associated with climate change. This includes a serious assessment of risk across borders and all segments of the financial system, including banking, insurance, pensions, and other investments. The Federal Reserve has taken action and is now a member of the Central Banks and Supervisors Network for Greening the Financial System. The administration should also be commended for its commitment to address climate threats with rejoining the Paris Climate Agreement and by creating the National Climate Task Force.

All financial regulators, both individually and collectively in the Financial Stability Oversight Council, must emerge from the sidelines and confront the interplay of finance and climate change. Market regulators such as the Securities and Exchange Commission as well as the Commodities Futures Trading Commission should take critical steps to ensure that climate risk information is available to the firms they oversee so it can be reflected in investment and price decisions made by market participants.

Banking regulators led by the Federal Reserve should add climate risk into prudential oversight, including stress testing of institutions. The Financial Stability Oversight Council should coordinate such efforts to take a better look at systemic vulnerabilities. This should include a full assessment of the effects of a serious climate disruption and the odds of steep market losses as well as any serious insurance underwriting losses.

Public patience is wearing on whether environmental regulation, private ordering, and investor pressures are enough to chance corporate climate behavior. But we must balance the speed of this change with discipline to preserve regulation for its purpose of protecting financial system stability. Perceptions that regulators use their authorities to advance environmental policy, no matter how worthy, will undermine support for dealing with the real financial risk that climate change presents to the world.

It has been said that the true test of society is the kind of world it leaves its children. Climate change represents a significant risk both now and to future generations. It is naive to think that somehow the financial system will remain immune to the inevitable economic losses that will ensue if there are no forceful efforts to identify and prevent them. With climate change, the worst is yet to come. The time for action is now.

Sheila Bair is the founding chair of the Systemic Risk Council who served as the chair of the Federal Deposit Insurance Corporation in Washington.