Fed Chair Powell’s position on climate change ‘has become more and more full-on’: Expert

Better Markets Director of Banking Policy Phillip Basil joins Yahoo Finance’s Akiko Fujita and Zack Guzman to discuss how the Federal Reserve is approaching climate risk.

Video Transcript

AKIKO FUJITA: Well, turning our attention to the Fed. Jerome Powell's renomination to a second term as Fed Chair disappointed a lot of progressives who have advocated for a stronger climate policy coming from the central bank. So what is that policy likely to look like under his second term? Let's bring in Phillip Basil. He's Better Markets Director of Banking Policy. He's also a former supervisory financial analyst for the Federal Reserve.

And, Phillip, it's great to have you on today. When you think about the Fed's climate policy, the frustration coming, at least, from the progressives hasn't necessarily that the Fed hasn't done anything, it's that they haven't moved quickly enough addressing the urgency of what's at hand right now. To what extent do you think that shifts in a big way under Jerome Powell's second term?

PHILLIP BASIL: Yeah. Thanks, Akiko. Well, I think it will shift in at least a material way. When you look at the language from Jerome Powell throughout the year, I mean, at first, certainly earlier in the year it was a lot more reserved around how exactly the Fed's going to address climate. But throughout the year, sort of increasing in both frequency and in what Powell has said the Fed can do and what the Fed is planning to do. His position has become more and more full on towards addressing climate change.

I mean, he's made statements to Congress. He has made statements after the Financial Stability Oversight Council released its report. And most recently in his statement after his nomination, he identified climate as a key priority. So I do see that the Fed picking up the pace a bit on addressing climate change, but especially with Brainard being elevated. And she has been quite vocal on addressing climate change.

In her most recent speech around scenario analysis, she points to the efforts the Fed is starting to undertake. And in that speech, she also mentioned how you know there is a need for additional data to be able to sort of get a handle on sizing the risks from climate.

- Yeah, Phillip. I mean, despite kind of Jay Powell's increased talk about climate change, still wasn't enough to really get any support from those most progressive. Of course, we saw Elizabeth Warren raise her issues with Jay Powell, but those weren't necessarily climate change related. When we talk about, maybe, what Lael Brainard brings to the team here as she is nominated for Vise Chair, how does that maybe change the dynamic of what we might see from a Jay Powell? A lot of people talking about it being a dove and a dove here. So what does that maybe do to the policy decisions moving forward?

PHILLIP BASIL: Well, I think just judging from what we've seen so far and what we've heard so far, this is increasingly becoming a top of mind risk for the Federal Reserve. I mean, it's becoming harder and harder to ignore. When you look at the data, and not only the incidence of climate disasters increasing, roughly, five-fold since the 1970s and financial costs to the economy increasing roughly in line with the increase in incidence, it's becoming harder and harder for the Federal Reserve or any Prudential regulatory authority to ignore.

And I do believe with both Powell and Brainard, as I mentioned, they will be stepping up efforts. What exactly does that look like? How quickly do they come online? We will see. But certainly a better markets. We will be pushing the Federal Reserve to pursue efforts as quickly as possible.

I mean, certainly over the next year as they've indicated, you can see scenario analysis. The Fed really should be hammering home the point that managing and addressing climate risks are part of supervisory assessments and should be part of bank's overall supervisory scores. And the Fed should be doing this pretty much immediately. And they could be doing this immediately, similarly with scenario analysis.

Certainly by next year, I mean, we would like to see in the next couple supervision and regulation reports, we would like to see some results of scenario analysis. In Europe at the ECB and the UKPRA, they've already made progress on this. And they've announced results of their scenario analysis will be released next year. So these are certainly two efforts the Federal Reserve could sort of step up and pursue more immediately.

AKIKO FUJITA: What about something like capital requirements, Phillip? There's the argument that for every dollar that a bank invests in fossil fuels, the bank needs to hold an equal amount, essentially to absorb future losses. I mean, there's a big question about whether, in fact, some of these stranded assets could lead to instability in the financial markets. How much of that do you think should be considered and how effective do you think that kind of policy could be?

AKIKO FUJITA: I'll start with the second part of that question and how effective it can be. And it can be very effective. I mean, let's think about what the Fed's mandate is here. And you might hear from some others on the other side of this issue saying, well, climate really isn't in the Fed's mandate. But that's just not true. I mean, it's the contrary. It isn't the Fed's mandate because they're charged with the stability and safety and soundness of the banking sector, as well as overall financial stability. And climate places squarely into that.

And so, when you talk about capital requirements, well, that's part of safety and soundness of the banking sector. So to say that the Federal Reserve should not be putting in place capital requirements is kind of an absurd statement when you think about the risk that climate could pose to the banking sector.

And so, in our recent report that we released, we highlight that, yes, the Fed should be considering capital requirements. We say that you it makes probably a little more sense to pursue it through the Fed's stress test and the stress capital buffer just because that necessarily is scenario based.

But the climate does pose risks to the financial sector, it poses a risk to banks. In the case you were pointing out, let's say banks finance exploration of new fossil fuels, well, assuming transition happens according to the goals that the international community has agreed to, a lot of those assets could be left stranded and cause significant losses on banks' balance sheets. And you'll end up with mispriced risk. And that's where capital requirements are key to this picture.

AKIKO FUJITA: You mentioned potential stress tests. You look at somebody like the Bank of England. I mean, some would argue they've kind of been leading the way on climate policy. To what extent do you think the test they've conducted could be a model for the Fed to follow? I mean, is it fair to make the two comparisons to say, look, over in the UK, as well as Europe, they've already led the way, they've created a model for the Fed to follow.

AKIKO FUJITA: You know, in some ways, I think that is true, but let me point out that the Federal Reserve has stood up and runs what could be considered the world's most robust stress testing program. It's a bottoms up stress test, asset level stress test for the largest banks here in the United States.

And along with that, the Federal Reserve collects quite a bit of data. I mean, imagine. They collect every loan, nearly every loan on the balance sheet, every mortgage, commercial loans, commercial real estate, commercial and industrial loan. And they collect quite a number of variables along with that.

So I'm fully confident that the Federal Reserve can create a scenario analysis and, eventually, a stress tests related to climate that equally to its current stress test will be the most robust stress test in the world. And they have the capability, they have the staff, they have the infrastructure. And so, this is, to me, not necessarily a heavy lift. The last piece of the puzzle that might be missing is a little more data around the specific climate risks associated with each asset.