Senior regulators said there is an urgent need to address climate risk, but they are open to a range of collaborative approaches and are not seeking to implement rigid stress tests anytime soon.

Both Michael Barr, the Federal Reserve's new vice chair for supervision, and Acting Comptroller of the Currency Michael Hsu embraced a focus on risk management instead of a role as broader instruments of climate policy.

The Fed's "mandate in this area is important, but narrow, focused on our supervisory responsibilities and our role in promoting a safe and stable financial system," Barr said in a speech Sept. 7. He added that "you're not going to see us tell firms: Lend to this sector or don't lend to this sector."

Barr did not borrow Fed Chairman Jerome Powell's "favorite phrase of 'staying within our lane,' but he might as well have," Ian Katz, a policy analyst at Capital Alpha, said in a note.

The message is consistent with what officials have been saying for some time as the effort to evaluate and mitigate climate risk in the financial system has gained momentum. Progressive groups have advocated for changes to capital standards that would restrict fossil fuel financing, while the industry has argued that regulators should focus exclusively on risks to banks from climate change.

"We're not going to be getting into broader questions of climate policy," Barr said. "That's for other agencies, and for the Congress, for the president."

Addressing the issue of how to measure and control climate risk, Hsu said there is an urgent need for large banks "to operationalize scenario analyses and to prioritize diverse approaches to such efforts over one-size-fits-all stress tests."

"A strong emphasis on the diversity of approaches needs to be maintained," he added, speaking Sept. 7 at a conference hosted by The Clearing House and the Bank Policy Institute. "We are much more exposed to failures of imagination — not asking enough 'what if?' questions — than we are to failures of severity or consistency."

Hsu said that "the muscle memory of capital stress testing is more likely to handicap climate scenario analysis than to help it."

Barr said the Fed would launch "a pilot micro-prudential scenario analysis exercise" next year. "We're going to be working with just a handful of the very largest financial institutions in the country," he said. "It's really the beginning of beginning to understand how these risks are managed."

He noted that it would be a learning exercise without "direct capital or supervisory implications."

Big banks including JPMorgan Chase & Co., Bank of America Corp. and Citigroup Inc. have described conducting preliminary scenario analyses in public reports.

Barr and Hsu said that regulators would seek to deliver harmonized guidance on climate risk management for large banks in the near term. Both officials emphasized caution about climate regulation for community banks.

Hsu said he has frequently heard concerns from community banks about the potential burden of new regulation and said, "I want to acknowledge those concerns and commit to continued open dialogue and constructive engagement as we move forward."

Asked whether he thinks markets are currently underestimating climate risk, Barr said, "We're at such an early stage in this process that I couldn't begin to answer your question."