FHFA shares ‘lessons learned’ from evaluating exposure to climate-related risks

Federal Issues FHFA Fannie Mae Freddie Mac Climate-Related Financial Risks Flood Insurance Risk Management

On May 1, the FHFA released a report covering the “lessons learned” from its review of the Climate Scenario Analysis (CSA) which was used by financial institutions and regulators to evaluate exposure to climate-related risk. Climate-related risk can be categorized in two ways: (i) physical risk which is damage to property, land, and infrastructure due to severe weather and environmental changes; and (ii) transition risk that results from policy and technological shifts towards a low-carbon economy.

In its preliminary CSA exercises, the FHFA made the following key observations:

1. Data and Methodology Limitations: There were data limitations and methodological shortcomings as current tools depend on incomplete data.
2. Modeling Assumptions: Results were significantly impacted by modeling assumptions.
3. Challenges with Existing Credit Models: Current credit loss models were constrained while incorporating climate risks.
4. Predictive Inaccuracy: The tools used to estimate the historical relationship between climate-related events and financial impacts may not be representative of future financial impacts.

The FHFA concluded that these findings indicated the CSA a complex process with room for enhancement and that no single risk assessment can fully capture the breadth of potential impacts from climate-related physical and transition risks.