Climate Risk Regulations Will Likely Target Community Banks

By Jeff Gruetzmacher

Community banks have generations of experience managing concentration risks and responding to extreme weather events and natural disasters in their communities. They have long weighed a broad range of risks involved with investing in businesses and asset classes and have employed a range of risk management strategies such as hedging and hazard, crop, flood, and life insurance.

Bankers know their communities and loan portfolios better than anyone else, as evidenced by the absence of community bank failures following severe weather events.

While several federal regulatory agencies are working to finalize proposals on climate-related financial risk management that target the nation’s largest financial institutions, the proposals would inevitably subject Wisconsin community banks and the communities they serve to new and expensive regulatory burdens. This new onerous framework is counterproductive and unnecessary.

Climate risk management frameworks proposed by the Federal Deposit Insurance Corporation (FDIC), Office of the Comptroller of the Currency (OCC), and the Federal Reserve Board (FRB) purportedly target banks over $100 billion in assets, but regulators have publicly signaled the policies will ultimately trickle down to community banks. Regulation creep is real, as evidenced by the Current and Expected Credit Loss (CECL) regulations.

The FDIC recently said in a speech at the American Bankers Association’s (ABA) Annual Convention in October that all financial institutions are subject to climate-related financial risks, while the OCC stated in March of 2022 that their examiners will conduct climate risk management examinations on community banks in the coming years. Regulators have made their intentions clear: community banks will not get a pass.

The largest conundrum is how community bankers can assess their risks of climate change, without customers first accounting for climate risks themselves? And what resources and costs will be necessary for customers to perform their own climate risk assessment and disclose required greenhouse gas emissions data as a condition of banking? These extra costs will also burden rural communities and citizens.

For example, will a dairy farmer need a methane gas emission report to obtain a loan? Will banking the local gas station be red flagged by regulators? And what about a trucking company using older diesel trucks and not enough electric ones? How risky is banking a manufacturer making artic boots when we might have milder winters?

Even consumers could be a target of additional oversight and reporting. Will homes financed need to have a renewable energy heating system or efficiency score? The practical questions are limitless.

An open-ended climate risk regulation may give birth to endless and costly rabbit holes that community banks will be forced to go down in an effort to play infinite what-if games.

Community banks could also be forced to pick favorites in industries that are disfavored but legal. Some question if this is a reintroduction of “Operation Choke Point” version 2.0, where the agencies use the financial system to pick winners and losers in industries that Congress itself continues to make legal.

And then let’s talk about costs. Community banks would have to pay a myriad of expenses to comply with climate risk management frameworks — including hiring subject matter and compliance experts to implement these complicated frameworks.

Finally, overlooked but problematic, is the Securities and Exchange Commission’s (SEC) proposal to institute climate-related investor disclosures, which contains no exemption for community banks. This threatens to impose unprecedented costs and potential liabilities that would drive local institutions out of the public capital markets.

Rather than impose new climate-related rules on community banks, regulators should continue to utilize existing and effective risk management supervision practices that have long been proven and sound.

The conversation shouldn’t be about introducing new regulations — the conversation should be about what community banks will continue to do, as they have for generations, to successfully mitigate all risks, including climate. Additional regulatory frameworks and burdens are simply not needed.

Gruetzmacher is senior vice president and director at Royal Bank, Elroy. He serves on ICBA’s Agriculture — Rural America Committee and is a past chair of the WBA Agricultural Bankers Section Board of Directors.