Researchers at the Federal Reserve Bank of New York sought to find out how badly banks’ bottom lines have been affected by weather disasters. Their provocative answer: “Not very.”
The researchers examined what happened at banks in the wake of tornadoes, hurricanes, floods, wildfires and other disasters across the United States between 1995 and 2018. At banks heavily concentrated in the geographic areas affected, their study found modest increases in loan-loss rates, but it also found small upticks in profitability.
One potential explanation offered by the authors is straightforward: more lending in the wake of natural disasters means more income for banks.
“Households and businesses alike may need credit to rebuild and repair following a destructive event,” two of the study’s co-authors wrote in a blog post published Monday by the New York Fed. “Banks’ earnings on new loans can offset losses on prior loans and even, as we found, strengthen their bottom lines somewhat.”
The report’s findings — particularly coming from the Federal Reserve — will likely serve as a talking point in the politically charged debate over whether and how to incorporate climate risk into banking risk models and regulatory oversight.
Senate Republicans and Sen. Joe Manchin, D-W.Va., recently torpedoed the nomination of Sarah Bloom Raskin to be the Fed’s vice chair for bank supervision, citing her support for the use of financial regulation to fight climate change.
The report’s authors — who include the economists Kristian Blickle and Donald Morgan of the New York Fed — concluded that weather disasters are not likely to be a material source of bank instability. That finding is true, they wrote, even for banks that operate only in a single county where the disaster occurred.
“Even very small banks facing extreme disasters are not substantially threatened,” the paper’s authors wrote.
But the economists’ conclusions come with significant caveats that they readily acknowledge. First, their research is backward-looking. If future disasters prove to be orders of magnitude more severe than those in the past, there remains cause for concern about bank stability, the authors wrote.
Another limitation is that the New York Fed study only accounts for the so-called physical risks to banks, a category that includes the risks from severe weather events. Risk managers also talk about the notion of transition risk — the idea that banks exposed to carbon-intensive industries may suffer as a result of the transition to a low-carbon economy.
“The authors are very upfront about the limitations of their work,” Jeremy Kress, co-faculty director of the University of Michigan’s Center on Finance, Law & Policy, said in an interview, when asked about the New York Fed study.
“Companies are being downgraded as credit rating agencies realize that carbon-intensive businesses aren’t viable in the long run,” he noted.
Kress, a former bank regulation attorney for the Federal Reserve Board, published his own paper Tuesday about climate risk. His findings serve as something of a counterpoint to the New York Fed research, underscoring the complexity of the empirical issues involved.
Kress argues that U.S. banks are particularly vulnerable to climate change, compared with banks in other countries, due to a provision in the Dodd-Frank Act that bars regulators from relying on credit ratings in setting capital requirements.
He notes that U.S. bank capital rules, unlike those in numerous other countries, assign a flat risk weight to all corporate exposures, regardless of factors such as creditworthiness or climate risk.
His concern is that carbon-intensive companies globally — which he says pose a greater risk to banks as the economy transitions to cleaner energy — will flock to the U.S. banking system.
“At the extreme, herding by ‘brown’ companies into the U.S. banking system could trigger another financial crisis,” Kress wrote in the paper.
