Co-authored with Richard Berner, NYU Stern Clinical Professor of Finance and Co-Director, Volatility and Risk Institute.

Many sources of risk threaten the U.S. financial system. Pandemic risk and cyber risk are at or near the top of our list of nightmares. Yet, with the UN Climate Change conference (COP26) under way in Glasgow, attention is shifting to efforts aimed at limiting the economic and financial damage from climate change, including a timely new “Report on Climate-related Financial Risk” from the U.S. Financial Stability Oversight Council (FSOC).

As the Report makes clear, U.S. policymakers need a far better understanding of climate-related financial risk. Indeed, when President Biden issued an executive order in May instructing financial regulators to conduct a thorough risk assessment, the United States already was behind other advanced economies. As an initial response to the President’s directive, the Report catalogs the range of climate risk threats, describes actions individual U.S. regulators have begun taking to address them, and lists many things that still need to be done. By setting priorities, the FSOC is now putting climate change “squarely at the forefront of the agenda of its member agencies.”

In this post, we highlight three themes in the Report: (1) the ongoing rise of physical climate risk; (2) the conceptual challenges associated with measurement, as well as the data gaps; and (3) the benefits of scenario analysis as a tool for assessing the financial stability risks arising from climate change. The key lesson that we draw from scenario analysis is that a financial system resilient to a range of other shocks is more likely to be resilient against climate risk. Put differently, a less-resilient financial system is vulnerable to all types of shocks, including those arising from climate change.