Climate change is humanity’s greatest challenge for the XXI^st century. Its effects will be felt for generations to come. And it poses major risks in the medium-to-long run. In light of this, bank regulators move very cautiously, and unevenly among the different pillars of bank regulation (prudential rules, disclosure and supervision). This article explains why. Embedded in prudential rules lie conventions that determine who bears the epistemic burden of establishing the existence of a risk, and what is the epistemic threshold to be met. This burden presents a challenge when the problem is not so much risk, but uncertainty, where assigning probability to the occurrence of an event may not be possible. Bank regulators and authorities, and, by extension, the legislators that adopt the rules that govern supervisory activity are less concerned about risks’ “science”, than about risk policy and law. Thus, they do not necessarily choose the tools that could tackle the risks more effectively (scientifically speaking) but the ones that may more easily withstand a burden of justifiability before the courts or in other fora. This helps explain how climate risk’s assimilation has been limited within prudential requirements (Pillar 1), broader, but hesitant in Pillar 3 (disclosure and market discipline), and more decisive within supervisory review (Pillar 2), which appeals to supervisory judgment and discretion. A deeper study of conventions and social norms could shed some light on how to better pursue prudential goals, concerning climate change and beyond.

Read the entire article here: https://ssrn.com/abstract=6149067 or https://dx.doi.org/10.2139/ssrn.6149067.