Notice & Comment

A Response to Adam White, by Todd Phillips

In his recent Notice and Comment post, Professor Adam White noted that “[f]inancial regulators are reshaping themselves into tools of climate policy.” Throughout the piece, he asserted that that “the Fed’s latest step [is] toward becoming a major climate policymaker,” and that the central bank’s agency is “expanding…to encompass climate policy.”

This is not true.

With all due respect, I am surprised that Adam has gotten caught up in the spin surrounding climate and banking regulation and am disappointed that he didn’t explain what is actually being contemplated. To be sure, there is significant misinformation out there, and I am personally frustrated that political advocates frequently argue for policies that are not permissible under current law. But that misinformation should not be confused with what is legally allowable and what the Federal Reserve is contemplating. I wrote an op-ed for the politico audience on this topic recently, but it is worth diving into detail for the law professors and practitioners who read this wonky blog.

Bank regulators’ actions are, with some exceptions, limited to those which would ensure that banks do not operate in an “unsafe or unsound condition.” They generally do this by making banks aware of the risks of their activities (e.g., providing written guidance of potential risks, requiring banks to analyze their loan portfolios’ risks), by ensuring that banks maintain and follow written policies and procedures for taking risks into consideration when making loans (e.g., conducting bank examinations), and by requiring banks to fund increasingly risky loans with increasing amounts of shareholder equity (e.g., capital requirements).

And climate change poses risks to bank loans, but in the same ways that loans traditionally face risks. Among the risks banks face, farmers may be unable to repay their loans because weather changes may destroy their crops (i.e., credit risk), and that oil and gas companies may be unable to repay their loans because their product becomes obsolete (i.e., market risk). Banks also face operational risk from their own activities being disrupted if their offices are closed due to extreme flooding or wildfires. As I noted in my op-ed, “[r]egardless of whether a bank has failed because of climate change, theft, or simple mismanagement, it cannot take deposits, make loans, or otherwise support the economy.”

One thing that bank regulators cannot do is to tell banks that they must divest entirely from certain lines of business, such as loans to oil and gas companies. At most, regulators can require that banks fund these loans entirely with equity instead of government-insured deposits. This may make certain loans less profitable for banks and therefore banks may be less inclined to make them, but this policy intervention is a far cry from bank regulators being “major climate policymaker[s],” as Adam wrote.

Further, the Federal Reserve Board and its fellow banking regulators are all government agencies that must comply with the Administrative Procedure Act. Accordingly, capital requirements for certain loans (whether those loans may be funded with no shareholder equity, funded entirely with shareholder equity, or somewhere in between) must be justified in notice-and-comment rulemakings and are subject to hard look review by the courts.

It is true that bank regulators have significantly more authority to regulate entities under their jurisdiction than many other federal regulators (the banking statutes are quite ambiguous and bank regulators are likely to receive deference to their interpretations, something I write about in a forthcoming article). And, as Professor David Zaring notes in a forthcoming article (which does not appear online), banks sue their regulators at a disproportionately low rate. But importantly, that authority is cabined by the dictates of the agencies’ organic statutes and the principles of administrative law.

So, what is the Fed actually considering doing on climate change? It’s going to send out guidance about climate risks. It’s going to require that banks conduct scenario analyses to ensure they understand the climate risks they face. And it might make loans to oil and gas companies more expensive (though I personally have doubts as to how much more expensive these loans can be made in the short-term without violating State Farm). Despite what Adam may claim, this is nowhere near “the stuff of climate legislation.”

If I have one take away for readers, it’s this: Despite the increasingly hot rhetoric, the Fed is dealing with a new risk to banks, is using the same tools it’s used for decades, and is simply doing the job Congress charged it with.

Todd Phillips is a non-resident fellow with the Duke Law Global Financial Markets Center and is a policy advocate in Washington, D.C. The views expressed are his alone and not of any affiliate or employer.