What does the executive order on climate-related risk mean for agricultural finance?

The recent federal executive order on climate-related financial risk institutes a whole-of-government approach to assessing and mitigating climate-related financial risk, with the goal of bolstering 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 U.S. agriculture’s position as a global leader long into the future will require the sector to address climate risk head-on, and soon, with innovative financial solutions that move beyond managing risk and move toward financing resilience.

Here are some of the implications of the executive order for agricultural finance institutions, and opportunities for these institutions for support a more resilient and prosperous food system.

Implications for USDA lending policies and programs 

The executive order mentions agriculture just once, requiring the Secretary of Agriculture to consider approaches to better integrate climate-related financial risk into the U.S. Department of Agriculture’s federal lending policies and programs.

Of approximately $374 billion in total farm debt, the USDA’s Farm Services Agency provides nearly 3% through direct loans and guarantees another 4% to 5% of agricultural loans that are administered by other lenders. The executive order could impact underwriting standards, loan terms and conditions, and asset management and servicing procedures for these loans.

The executive order also requires a government-wide climate-risk strategy to identify and disclose climate-related financial risk 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 Farm Credit System

The vast majority of agricultural loans for land and farm inputs are provided by commercial banks and the Farm Credit System, which together hold approximately 80% of agricultural debt. Banks and Farm Credit lending associations are regulated separately and therefore treated differently under the executive order.

The executive order requires the Financial Stability Oversight Council (FSOC) to assess climate-related financial risk to the U.S. financial system and recommend actions by federal financial regulators to reduce risk, including plans to improve climate-related disclosures and other sources of data, and to incorporate climate-related financial risk into regulatory and supervisory practices. Climate risk assessment and disclosure is a key building block needed to ensure 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 impact the federal regulators of commercial banks, a sector 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 may be required of smaller banks that have less capacity to undertake these assessments.

The Farm Credit System is regulated by the Farm Credit Administration, which is not included in the executive order and does not fall under the FSOC. However, Farm Credit has historically followed the Securities and Exchange Commission’s (SEC) guidance on risk disclosure at the system-wide level. The SEC is included in the FSOC and is now seeking public comment on climate-related financial disclosures.

If the Farm Credit System intends to continue following the SEC’s guidance, the order will also apply to Farm Credit at the national level. Its lending associations would not be required to disclose climate risks individually, though they would likely need to provide some information to roll up into the system-wide risk assessment.

Farm Credit should push forward on climate risk assessment and disclosure 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 lending institutions better understand climate risks to their lending portfolios by measuring how climate impacts affect existing credit risk ratings and probability of default calculations.

Major financial institutions around the globe are increasingly recognizing their role in assessing and disclosing climate risk. However, agriculture is lagging behind other sectors.

Commercial agricultural lenders and the Farm Credit System can advance climate risk assessment frameworks and tools in collaboration with nonprofit partners and financial climate risk software companies. These frameworks will need to be adapted to fit the capacity and needs of both 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 to their portfolios. U.S. agricultural lenders can start adapting these frameworks for their agriculture portfolios in collaboration with firms that develop software to measure climate risks to bank portfolios and better factor these risks.

How agricultural finance institutions can mitigate climate risk

There are several paths to risk mitigation, including but not limited to divesting from the riskiest types of farming or agricultural regions, increasing reliance on federally subsidized risk mitigation programs like crop insurance, and collaborating 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 would do nothing to address the underlying risk itself and would be devastating to producers, particularly 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% in the next 30 years if climate change continues unabated.

Ultimately, the most responsible approach to reducing long-term climate-related financial risks in agriculture includes helping farmers both mitigate agricultural greenhouse gas emissions and build resilience to climate impacts such as drought and extreme rainfall. Fortunately, many of the same farm management changes can do both by rotating a variety of crops and livestock, building the health of the soil and managing water efficiently.

Now it’s just a matter of agricultural business and financial leaders responding quickly to meet the needs of farming for the future.