The climate crisis is more than sweltering summers and ferocious storms. Its reach now extends into the financial sector as banks navigate escalating physical losses and uncertainties linked to decarbonization. The combined effect is mounting pressure on asset values, collateral, and cash flows in ways that can erode institutional solvency. Yet while foreign regulators are building frameworks for climate-related financial risk, U.S. federal banking agencies are pulling back from similar climate-focused initiatives. In this environment, state banking regulators—given their proximity to local markets and institutions—are uniquely positioned to advance climate risk oversight in ways that complement federal supervision.

 

Climate Risk Is Financial Risk

For the financial sector, climate change has already shifted from a distant worry to an active source of loss. Insurers are retreating from high-risk markets, mortgage lenders are tightening standards in flood-prone regions, and municipalities are seeing borrowing costs rise after repeated disasters.^[1] Foreign banking regulators have responded by embedding climate considerations into supervisory expectations, from integrating climate factors into stress testing to requiring institutions to assess and disclose climate exposures as part of capital planning.^[2]

During the Biden administration, U.S. banking regulators began similar work. For instance, the federal banking agencies jointly issued principles for climate risk management, outlining expectations for governance, scenario analysis, and risk assessment.^[3] Additionally, the Financial Stability Oversight Council (FSOC) released a report identifying climate change as an emerging threat to financial stability and called for coordinated data collection and supervisory standards across agencies.^[4] That momentum has now reversed. The Trump administration has halted or rescinded climate-related initiatives, disbanded interagency working groups, and withdrawn prior guidance.^[5]

 

Why Climate-Focused Oversight Is Not Redundant

Some argue that climate-specific policies are unnecessary because banks are already expected to manage all material risks.^[6] Yet climate change differs in both scale and structure from the risks prudential supervision was designed to address.^[7] Its effects span longer time horizons and multiple sectors, combining physical damage, market repricing, and policy shifts in ways that can amplify one another and challenge conventional oversight.

Experience abroad suggests these challenges remain under-addressed. The European Central Bank (ECB) found that many institutions still treat climate risk as a secondary concern, applying enhanced practices unevenly across portfolios and risk categories.^[8] Key business lines such as mortgage lending and operational risk may remain outside climate frameworks.^[9] This patchwork response indicates that existing supervisory tools, designed for cyclical downturns, must evolve to meet the demands of a structural transformation.

Environmental law offers a useful parallel: the precautionary principle counsels regulators to act on credible risks before they mature into crises. Just as environmental agencies are expected to prevent foreseeable harm, banking regulators must adapt oversight to a changing risk landscape.

 

How States Can Fill the Gap

The United States’ dual banking system grants supervisory authority to federal and state regulators, and state agencies supervise more than 75% of U.S. banks.^[10] Most of these institutions are community and regional lenders whose portfolios are tied to local sectors such as real estate, agriculture, and energy, leaving them exposed to climate risk.^[11] When wildfires threaten collateral, droughts disrupt agricultural yields, or new energy policies reshape local economies, state regulators are often the first to see those effects on balance sheets.

This proximity provides a practical advantage. State regulators’ deep knowledge of local markets and geographies allows them to identify emerging risks early and tailor supervisory expectations. A locally informed approach also supports proportionality: climate-related supervision shouldn’t impose unnecessary burdens on smaller institutions but instead focus on exposures most relevant to each region’s economy and each bank’s capacity.

State authority also extends beyond the banking system. Insurance companies are regulated primarily at the state level, giving state regulators visibility into one of the industries most directly affected by climate-related losses. In some states, the same department supervises both banks and insurers; in others, the functions are separate but closely coordinated. This structure enhances state regulators’ understanding of how climate risks impact local economies (e.g., property insurance availability and collateral valuation) and provides additional policy levers to respond.

New York’s Department of Financial Services (DFS) offers a useful example. Its 2023 climate risk guidance acknowledges that smaller institutions often have more limited resources and modeling capacity than larger firms and may face heightened vulnerability from concentrated business lines or geographies.^[12] The DFS guidance encouraged institutions to take actions appropriate to their size, complexity, and exposure^[13]—illustrating how state regulators, with their close understanding of local conditions, are well positioned to strike the right balance in overseeing climate-related financial risk.

From an environmental law perspective, this adaptability reflects the logic of cooperative federalism. Just as states tailor implementation of the Clean Air Act and Clean Water Act to local conditions while advancing national goals, state banking regulators can address climate risk through flexible, locally informed oversight.

 

Federalism and the Precautionary Duty of Finance

Environmental and banking law share a familiar pattern: when federal leadership recedes, states can lead. States pioneered air-quality standards before the Clean Air Act and consumer protection reforms prior to the CFPB.^[14] The dual banking system reflects the same design. States can’t rewrite capital requirements or supervise nationally chartered banks, but they can set supervisory expectations within their jurisdictions. Over time, consistent state practices can evolve into national norms, just as state emissions standards helped shape federal policy.

Banking regulators exist to anticipate threats before they become crises. Climate change fits that category: foreseeable in direction, uncertain in timing and scale, and severe in consequence. If federal agencies won’t lead, then state regulators can and should. Supervising climate risk isn’t a break with financial tradition. It is a return to it.

 

 

[1] Pierpaolo Grippa, Jochen Schmittmann, & Felix Suntheim, Climate Change and Financial Risk, F&D Magazine, Dec. 2019, at 26, 27-28; Press Release, U.S. Dep’t of the Treasury, Fact Sheet: The Impact of Climate Change on American Household Finances (Sept. 29, 2023), https://home.treasury.gov/news/press-releases/jy1775.

[2] Financial Stability Board, Supervisory and Regulatory Approaches to Climate-Related Risks 10 & 28 (2022), https://www.fsb.org/uploads/P131022-1.pdf.

[3] Principles for Climate-Related Financial Risk Management for Large Financial Institutions, 88 Fed. Reg. 74183 (Oct. 30, 2023).

[4] Financial Stability Oversight Council, Report on Climate-Related Financial Risk 6 (2021),
https://home.treasury.gov/system/files/261/FSOC-Climate-Report.pdf.

[5] Alastair Marsh, Fed Disbands Climate Groups Studying Financial Stability Risks, Bloomberg (May 28, 2025), https://www.bloomberg.com/news/articles/2025-05-28/fed-disbands-climate-groups-studying-financial-stability-risks?embedded-checkout=true; Joint Press Release, Federal Reserve Board of Governors Public Affairs Office, Agencies Announce Withdrawal of Principles for Climate-Related Financial Risk Management (Oct. 16, 2025), https://www.federalreserve.gov/newsevents/pressreleases/bcreg20251016a.htm.

[6] News Release 2025-27, OCC Public Affairs, OCC Withdraws Principles for Climate-Related Financial Risk Management for Large Financial Institutions (Mar. 31, 2025), https://www.occ.gov/news-issuances/news-releases/2025/nr-occ-2025-27.html.; Joint Press Release, Statement on the Rescission of the Principles for Climate-Related Financial Risk Management for Large Financial Institutions by Vice Chair for Supervision Michelle W. Bowman (Oct. 16, 2025), https://www.federalreserve.gov/newsevents/pressreleases/bowman-statement-20251016.htm.

[7] See Yevgeny Shrago & David Arkush, Looking Over the Horizon: The Case for Prioritizing Climate-Related Risk Supervision of Banks 7-10 (Roosevelt Inst. & Pub. Citizen eds., 2022), https://rooseveltinstitute.org/wp-content/uploads/2022/06/RI_Climate-Related-Risk-Supervision_202206.pdf.

[8] Frank Elderson, Banks Have Made Good Progress in Managing Climate and Nature Risks—and Must Continue, Eur. Cent. Bank: The ECB Blog (July 11, 2025),  https://www.ecb.europa.eu/press/blog/date/2025/html/ecb.blog20250711~f5c6a0259f.en.html.

[9] Id.

[10] State Financial Regulation 101, Conference of State Bank Supervisors (July 1, 2023), https://www.csbs.org/state-financial-regulation-101.

[11] Lilith Fellowes-Granda & Crystal Weise, How U.S. Regulators Can Help Community and Regional Banks Address Climate-Related Financial Risks, Ctr. for Am. Progress (Apr. 28, 2023),
https://www.americanprogress.org/article/how-u-s-regulators-can-help-community-and-regional-banks-address-climate-related-financial-risks/.

[12] NY Dept. of Fin. Servs., Guidance for New York State Regulated Banking and Mortgage Organizations Relating to Management of Material Financial and Operational Risks from Climate Change 9 (2023), https://www.dfs.ny.gov/system/files/documents/2023/12/dfs_climate_change_guidance_banking_mortgage_orgs_202312.pdf.

[13] Id. at 10.

[14] Arthur C. Stern, History of Air Pollution Legislation in the United States, 32 J. Air Pollut. Control Ass’n 44, 46-48 (1982).; Mark Totten, Credit Reform and the States: The Vital Role of Attorneys General After Dodd-Frank, 99 Iowa L. Rev. 115, 120-22 (2013).