The recent Federal Executive Order on Climate-Related Financial Risks institutes a whole-of-government approach to assess and mitigate climate-related financial risks, with the aim of building the resilience of financial institutions and the communities they serve.
As a sector dependent on natural resources and predictable weather conditions, agriculture is particularly vulnerable to climate change. Maintaining the world’s leading position in U.S. agriculture over the long term will require the sector to tackle climate risk head-on, and soon, with innovative financial solutions that go beyond risk management and move towards financing resilience.
Here are some of the implications of the decree for agricultural financial institutions, and the opportunities for these institutions to support a more resilient and prosperous food system.
Implications for USDA Lending Policies and Programs
The executive order only mentions agriculture once, forcing the Secretary of Agriculture to consider approaches to better integrate climate-related financial risks into federal lending policies and programs of the US Department of Agriculture.
Out of about $ 374 billion in total farm debt, the USDA Farm Services Agency provides nearly 3% through direct loans and guarantees an additional 4-5% in agricultural loans administered by other lenders. The decree could affect underwriting standards, general loan conditions, and management and asset management procedures for these loans.
The decree also requires a government climate risk strategy to identify and disclose climate-related financial risks to government programs, which should include the federal crop insurance program, a key risk mitigation tool for many farmers and their lenders.
Implications for commercial banks and the agricultural credit system
The vast majority of agricultural loans for land and agricultural inputs are provided by commercial banks and the Agricultural Credit System, which together hold around 80% of agricultural debt. Banks and agricultural credit associations are regulated separately and therefore treated differently under the decree.
The executive order requires the Financial Stability Oversight Council (FSOC) to assess climate-related financial risk to the U.S. financial system and recommend action by federal financial regulators to reduce risk, including plans to improve climate-related disclosures and other data sources; and integrate climate-related financial risk into regulatory and supervisory practices. Climate risk assessment and disclosure is a key element necessary to ensure that climate risks are measured and managed effectively, and a learning opportunity to share best assessment and mitigation tactics.
The directive to the FSOC will primarily affect federal regulators of commercial banks, an industry that includes both large multinational banks and small community banks. While many large commercial banks are already embarking on climate risk assessment and disclosure efforts, a key question is what can be required of smaller banks that have less capacity to undertake such assessments.
The agricultural credit system is regulated by the Agricultural Credit Administration, which is not included in the decree and does not fall under the FSOC. However, Farm Credit has historically followed the Securities and Exchange Commission (SEC) guidelines on system-wide risk disclosure. The SEC is part of the FSOC and now invites public comment on climate-related financial information.
If the farm credit system intends to continue to follow SEC guidelines, the ordinance will also apply to farm credit at the national level. Its lending associations would not be required to disclose climate risks individually, although they would likely need to provide information to be incorporated into the system-wide risk assessment.
Agricultural credit should advance the assessment and disclosure of climate risks in order to facilitate effective and financially sound decision making by the system and its lending associations in the face of climate change.
How agricultural financial institutions can assess climate risk
Conducting climate risk assessments can help agricultural credit institutions better understand the climate risks to their loan portfolios by measuring how climate impacts affect existing credit risk ratings and probability of default calculations. .
Large financial institutions around the world are increasingly recognizing their role in assessing and disclosing climate risks. However, agriculture lags behind other sectors.
Commercial agricultural lenders and the agricultural credit system can advance climate risk assessment frameworks and tools in collaboration with nonprofit partners and financial climate risk management software companies. These frameworks will need to be adapted to suit the capacity and needs of large and small lenders.
The United Nations Environment Program Finance Initiative has developed and piloted frameworks for commercial banks to measure the financial risk of climate change for their portfolios. US agricultural lenders can begin to adapt these frameworks for their agricultural portfolios in collaboration with companies that are developing software to measure the climate risks of bank portfolios and better account for those risks.
How agricultural finance institutions can mitigate climate risk
There are several ways to mitigate risk including, but not limited to, divestment from the riskiest types of agriculture or farming regions, increased use of federally funded risk mitigation programs , such as crop insurance, and working with producers to reduce risk by building resilience to climate impacts.
The first two options would address some of the financial consequences of climate risk but do nothing to address the underlying risk itself and be devastating for growers, especially the 85% of U.S. farms not enrolled in crop insurance. And studies show that the cost of the federal crop insurance program could increase by 40% over the next 30 years if climate change continues unabated.
Ultimately, the most responsible approach to reducing long-term climate-related financial risks in agriculture is to help farmers mitigate agricultural greenhouse gas emissions and build resilience to climate impacts. such as drought and extreme rainfall. Fortunately, many of the same changes in farm management can do both by alternating a variety of crops and livestock, strengthening soil health and effectively managing water.
Now it’s just a matter of farm businesses and financial executives reacting quickly to meet the needs of tomorrow’s agriculture.