While sustainability initiatives continue to take center stage for banking and financial institutions globally, U.S. regulators have drawn a proverbial line in the sand.
A divergence has emerged among U.S. policymakers regarding the appropriate approach and level of involvement to institute climate regulations for large banks. Specifically, the Federal Reserve has expressed concern about the introduction of strict climate regulations endorsed by the European Central Bank (ECB), that are directing recommendations to the Basel Committee, a global organization that sets and promotes regulatory guidance among banks.
Along with concern from politicians about the evolving role of sustainability and ESG initiatives taking precedence in strategy and investment decisions, the Fed has recently pushed back on the committee’s proposed climate policy.
Below we discuss recent global regulatory developments enacted by the Basel Committee, how regulators are responding to provisions on both climate action and increased capital requirements for banks, and what the implications are for banks and investors going forward.
Fed Thwarts Global Climate Ambitions
The Basel Committee on Banking Supervision (BCBS) is an organization whose objective is to set and promote global banking regulation standards, monitor their implementation, and provide a forum for ‘regular cooperation on banking supervisory matters.’ Its 45 members comprise central banks and bank supervisors from 28 countries. The U.S. is represented by delegates from the Federal Reserve Bank, Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation (FDIC).
Under newly proposed regulations, banks would be required to publish detailed information about the impact of climate change on their business starting in January 2026. The Basel framework assesses Scope 1, Scope 2, and Scope 3 emissions. Scope 1 covers direct emissions from a bank, Scope 2 includes indirect emissions from purchases of energy, and Scope 3 includes greenhouse gas (GHG) emissions produced by a company’s customers.
Of the three, the Scope 3 GHG emissions, or ‘financed emissions’, were found to be the most contested in SEC filings. Financed emissions—those originating from companies that have received loans and investments— often represent the largest percentage of a bank’s GHG emissions.
Speaking to the proposed climate regulations, Federal Reserve Chairman Jerome Powell indicated it would be inappropriate to use monetary policy or supervisory tools to promote a greener economy or to achieve other climate-based goals. According to Powell, the Fed has no plans to be a ‘climate policymaker.’
Michelle Bowman, a member of the Federal Reserve Board of Governors, believes the climate guidance would adversely affect banks and discourage lending to certain industries, forcing them to obtain credit outside the banking system, overall increasing the cost of credit and passing the extra expense along to consumers. Additionally, there are potential consequences to exacerbate already limited credit and financing options to consumers and businesses in lower-middle income communities.
Similarly, members of the House Financial Services Committee and Subcommittee on Financial Institutions and Monetary Policy voiced concern about the growing influence of global governance bodies on U.S. bank regulation, specifically noting the Basel Committee and ‘opaque relationships’ between global governance bodies and U.S banking regulators.
Basel Committee’s Multi-Faceted Agenda
The Basel Committee’s climate agenda has evolved in tandem with overarching regulation aimed at expanding capital requirements for US banks. Under the ‘Basel III Endgame’ reform, US banks would be required to increase capital requirements by 16%, compared to the EU at 9.9%, and the UK at just 3%. The proposed policies would affect large banking institutions, those with $100 billion or more in assets.
In a written statement to the Senate Committee on Banking, Housing, and Urban Affairs, JP Morgan CEO Jamie Dimon criticized the proposed reform, warning it would ‘harm everyday Americans.’ “Ironically, a proposal to mitigate risk will create even more risk in the financial system. The proposed Basel III Endgame rule would unjustifiably and unnecessarily increase capital requirements by 20-25% for the largest banks. Banks would be limited in their ability to deploy capital, and the rule will have a harmful ripple effect on the economy, markets, businesses of all sizes and American households.”
Dimon believes the rule will result in banks no longer offering certain products and services, or having to charge substantially more for them.
Politicians and bankers alike believe the reform would weaken the competitiveness of US banks among clients and investors. They also say higher capital requirements for trading pose real consequences for businesses, and rules on credit risk threaten lending to everyday Americans and small businesses.
Lobbyists criticizing the proposed reform have even popularized their platform with national avenues such as ads on NFL Sunday Night Football, echoing the sentiment of bank leaders, politicians, and industry experts.
It is expected that the Fed will reveal substantially modified plans in the coming months, with politicians calling for consensus as the issue continues to linger.
A Sustainable Path Forward
While banks may not face strict climate regulations from a global governing body going forward, the focus on sustainability will continue to be an area of priority to meet the needs of their investors and customers. An emphasis on decarbonization will fuel the financing of low-carbon technologies and large-scale infrastructure.
As the global economy sets its eyes on achieving net zero emissions, investment banking is likely to be at the forefront of these initiatives. The transition, requiring substantial resource allocation, new technology, and innovation for projects, will largely be driven by bank financing. In addition to their own corporate sustainability initiatives, banks will indirectly support climate change and a greener economy.
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