Document Type
Article
Publication Date
4-2023
Abstract
Federal banking regulators are grappling with how to confront the threats posed by climate change. There are increasingly loud calls for regulators to adjust the “risk-weights” used to calculate banks’ minimum capital requirements based on how exposed their counterparties are to climate-related risks. This action could reduce risks to the financial system, and potentially make it less desirable for banks to lend to carbon- intensive activities. But other scholars have challenged the legality and administrability of this proposal. They argue that it is difficult to gather reliable empirical data about climate-related risks, and that any risk- weights that are not grounded in such data impermissibly deviate from risk-weights’ intended purpose.
This Article argues that these counter-claims are wrong. It does so by challenging the widespread misconception of the nature and function of risk-weights. Risk-weights are unavoidably discretionary policy instruments. They cannot simply be set through mechanical calculations, and always reflect a trade-off between limiting risks to banks (counseling setting a higher risk-weight) and enabling them to extend credit to a given activity in the real economy (counseling setting a lower one). At times, this trade-off has been explicit; it is always implicit in the exercise of regulatory discretion.
Further, Congress’ delegation of authority to the banking regulators reflects this understanding of risk-weights. In light of the complex policy challenge of setting risk-weights, Congress gave the regulators wide discretionary authority — generally exempt from judicial review — to engage in negotiation and experimentation. Yet when Congress has disagreed with how regulators have negotiated the risk- weight trade-off, it has reversed their decisions without restricting the delegation of authority. It may well be difficult to isolate climate-related financial risks in setting risk-weights. But this is no obstacle to regulatory action needed to protect the safety and soundness of the financial system.
Disciplines
Administrative Law | Banking and Finance Law | Law
Recommended Citation
Michaels, Joel, Capital Regulation as Climate Policy (April 16, 2023). 59 Idaho Law Review 127 (2023), SSRN: https://ssrn.com/abstract=4363645 or http://dx.doi.org/10.2139/ssrn.4363645
Available at: https://scholarship.law.columbia.edu/law_economy/1
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