Why We Need the Fossil Free Finance Act

By Yevgeny Shrago

Last week, Representatives Mondaire Jones, Ayanna Pressley and Rashida Tlaib introduced the Fossil Free Finance Act. The bill requires the Federal Reserve (Fed) to address the systemic risk that climate change presents to our financial system. Under the legislation, the Fed would mandate that the biggest banks stop financing the climate crisis and instead lend and invest responsibly, in line with science-based emissions goals that would keep global warming within 1.5°C. That’s the threshold that the Intergovernmental Panel on Climate Change has defined as necessary to avoid the worst impacts of the climate crisis.

What does this bill do?

This bill requires the Fed to use its existing regulatory authorities to protect individual banks and the financial system, which the Fed is tasked with overseeing, by reducing the amount of exposure that banks have to risky activities that produce greenhouse gas emissions. 

Net Zero Plans for Biggest Banks: The Fed would do this by requiring the largest banks, those with more than $50 billion in assets, to submit and follow a plan for achieving zero financed emissions by 2050. That’s a key target for protecting people from the most devastating impacts of the climate crisis.  

Financed emissions are the greenhouse gas emissions produced by a bank’s clients as a result of the bank’s lending, investment or other support. Adopting and following emissions reduction plans will keep banks from taking undue risks to squeeze a few last quarters of profits out of high emissions assets that will become prematurely worthless as the world transitions to a low carbon future.

Milestones: To avoid a fire sale from banks trying to meet their financed emissions reduction obligations at the last minute, the plans would need to include certain intermediate milestones, including: 

  • No financing of new or expanded fossil fuel projects after 2022
  • No financing for thermal coal projects or companies after 2024
  • No financing of any fossil fuel projects after 2030
  • A 50% reduction in the bank’s financed emissions by 2030

Environmental Justice: The bill also mandates that the Fed require the plans to account for the needs of the communities who are suffering the most from environmental racism. It limits the use of false or unproven solutions, like carbon offsets or carbon capture and sequestration technology. The plans must also prioritize removing funding from projects that cause disproportionate harm to vulnerable communities, as well as providing financing for companies to help workers affected by the transition to a low carbon future.

Penalties: Updated plans must be submitted every two years. If banks do not submit plans that meet the law’s requirements, or fail to follow the plans they submit, the Federal Reserve is instructed to fine the bank and its executives and to require the bank to sell assets to bring its business in line with the plan’s requirements. 

Shadow banks: The bill also adds financed emissions as a criterion for subjecting large, nonbank financial companies, like insurers, private equity funds, and asset managers, to enhanced oversight by the Fed. These entities, commonly known as “shadow banks”, are often lightly regulated, contributing to the 2008 financial crash. The designation process was created by the Dodd-Frank Wall Street Reform and Consumer Protection Act to help close this regulatory gap. By adding financed emissions as a consideration, the bill makes sure that non-bank financial institutions cannot just take over risky high-emissions finance from Wall Street megabanks.

Reports: To help with Congressional oversight, the Fed is required to report on its progress toward achieving the bill’s goals every two years. It’s also required to analyze the impact of the transition on workers and communities, and recommend ways that either the Fed or Congress can cushion that transition.

Support: This bill is co-sponsored by Representatives Adriano Espaillat, Marie Newman, Ritchie Torres, Chuy García, Jared Huffman, Alexandria Ocasio-Cortez, Emanuel Cleaver, Jamaal Bowman, Cori Bush, Jerrold Nadler, Mark Takano, Grace Meng, Pramila Jayapal, Ro Khanna, and James P. McGovern.

It’s endorsed by organizations including Public Citizen, 350.org, Evergreen Action, Sunrise Movement, Americans for Financial Reform, Sierra Club, Zero Hour, Stand.earth, Friends of the Earth US, Future Coalition, Action Center on Race and the Economy, and Revolving Door Project

FREQUENTLY ASKED QUESTIONS

Why is this bill important?

The climate crisis is creating risks that banks are failing to address. Even today, wildfires, hurricanes, and extreme heat are destroying homes, businesses and infrastructure across the country. The solution, a rapid transition to clean energy, would create millions of jobs, improve public health, and reduce energy costs. But U.S. banks have invested nearly $4T in fossil fuels since the Paris Agreement in 2015, even though such investments will become worthless if we are to get emissions under control in time to avert catastrophe. 

Unless the Federal Reserve puts a stop to it, banks will keep loading up on short term fossil fuel profits, even as the longer-term risks and consequences of their gambling threaten the financial system and economy. But to date, the Federal Reserve has taken no substantive actions to reduce or oversee the risk that banks—and people—face from the climate crisis.  

Why does the Federal Reserve have a role in addressing the climate crisis? 

The Federal Reserve is the only U.S. banking regulator with a full picture of Wall Street megabank operations. That role makes it the most important regulator when it comes to preventing financial crises. Its job is to protect the economy from excessive, unsafe risk-taking by these megabanks, and designated shadow banks. Like other central banks, the Federal Reserve has said that addressing the risks posed by climate change to financial stability is part of this mandate.

Does this bill change the Federal Reserve’s mandate or give it new powers?

No. The Federal Reserve could implement all of the requirements in this bill based on its current mandates to oversee bank safety and soundness and mitigate risks to financial stability. Banking regulators have long had the authority to limit concentrations of credit exposure and require banks to transition away from unsafe lending practices. This bill directs the Fed to use those powers to address the risk that financing emissions poses to individual banks and the financial system. 

How can banks and the Federal Reserve measure and reduce financed emissions?

Many banks have already committed to reach net-zero financed emissions by 2050, including Wall Street megabanks like Bank of America, Citi, and Morgan Stanley. The most popular method for measuring emissions, endorsed by these three institutions, is the Partnership for Carbon Accounting Financials, with over 150 members. 

Why does this bill only cover the largest banks?

This bill uses $50 billion in assets as a threshold because that is what Dodd-Frank used for defining a bank big enough to potentially pose a risk to the entire financial system. Failure of a bank like this is much more dangerous for the financial system and requires additional safeguards like the ones required in this bill. 

Can smaller banks and shadow banks (e.g., insurance companies, private equity funds and asset managers) start financing emissions to pick up slack from megabanks?

The four largest Wall Street megabanks, all overseen by the Fed, financed nearly a trillion dollars in fossil fuel production in 2020. Only these banks have the scale and sophistication to back the largest, most dangerous fossil fuel projects. Their size also lets them offer lower costs and a broader range of services, making more risky projects viable. Smaller banks might fund some of the projects that megabanks would have to refuse under this legislation, but they would not be able to grow fast enough to absorb all of the financing provided today.

Shadow banks are bigger, but they still will not fill the financing gap left by megabanks. They don’t have access to cheap financing in the form of deposits, making credit from them more expensive. The riskiest shadow banks also use loans from large banks to improve the returns of their deals, which this bill would deny them, making many high emissions projects unattractive. Large investment banks would also be unable to underwrite or otherwise facilitate financing transactions for shadow banks, a role they often play. 

For shadow banks that would still choose to finance large-scale emissions, this bill’s designation criteria will serve as a deterrent and backstop. Shadow banks have resisted designation and have even broken up their operations to avoid it, so it’s unlikely they will increase emissions in a way that makes designation more likely. And shadow banks that do trigger designation as a result of their financed emissions will need to make emission reduction plans similar to those of megabanks.   

How will changing the availability of bank financing affect fossil fuel production and other high emissions projects?

While it’s true that profitable fossil fuel projects will continue to draw investment, losing bank financing will have a significant impact at the margins. Even before the COVID crisis induced a Federal Reserve bailout of the industry, most fossil fuel companies were unprofitable, relying on debt financing to keep the pumps running. By shrinking the pool of available credit, the bill would eliminate many of these loser companies. Meanwhile, small banks and shadow banks will also require higher returns for even the portion of investment they can absorb, especially when they cannot rely on megabanks to provide a backstop or cheap leverage. This higher cost of financing will limit much of the risky fossil fuel expansion we see today. 

What impact would this bill have on communities who are economically tied today to fossil fuel production? 

The clean energy transition is already underway. As it continues, tens of thousands of fossil fuel industry workers will need to find new employment with the clean energy sector or elsewhere in the economy. That transition will be harder if the trend away from fossil fuel sector jobs is compounded by additional hardships from a financial shock like the 2008 crisis, which would shrink the economy and increase unemployment. This bill limits the danger of this worst-case scenario by keeping the fossil fuel transition on a science-based trajectory. The bill also provides benefits to help cushion the transition for communities and workers tied to the fossil fuel industry, both by encouraging banks to finance activities that smooth the transition for these communities, and by using its own lending powers to help states and municipalities finance a just transition.