RBI gears up to deal with climate-related financial risks

In a bid to make India’s financial system resilient to climate-related risks, the Reserve Bank of India (RBI) is mulling over possible regulations. As a start, the central bank has come up with a discussion paper on climate risk and sustainable finance and has asked for feedback from concerned stakeholders about the possible regulatory system in the near future. Simultaneously, the RBI released a survey report to highlight whether commercial banks in India are prepared enough to deal with risks related to climate change. 

In the discussion paper that was published on July 27, the RBI has sought suggestions on six aspects of devising regulations: the immediate priorities in shaping policy discourse; the way forward for the regulatory policy framework; main challenges in integrating the climate risk framework in governance; the overall timeline for implementation of the disclosure framework and potential challenges in developing climate risk stress testing; and a scenario analysis framework. The disclosure has to happen according to the standard set by the Task Force on Climate-Related Financial Disclosure (TCFD) which has been created by the Financial Stability Board, an international body to monitor the global financial system. 

To build a case for future regulation, RBI’s discussion paper says, “The uncertainty about the timing and severity of climate-related and environmental risk certainly threatens the safety, soundness, and resilience of individual Regulated Entities (REs) and, in turn, the stability of the overall financial system.” Regulated Entities refer to all kinds of banks given a licence under Section 22 of Banking Regulation Act 1949, financial institutions, non-banking finance companies, payment system providers, and all authorised persons including agents of Money Transfer Service Schemes (MTSS) etc.

Up until two years ago, the RBI had no initiatives to deal with climate-related financial risks, revealed a 2020 global survey by the Bank for International Settlements (BIS). Owned by 63 central banks, the BIS, in the survey, sought responses from central banks about the initiative they are taking to deal with climate-related financial risks. It received responses from 27 regulatory bodies. RBI was not one of them. When Mongabay-India reached out to BIS for a response over RBI’s recent initiative, the official response was “We have a policy of not commenting on the policies of member central banks.”

However, Suranjali Tandon, assistant professor at the National Institute of Public Finance and Policy (NIPFP) calls it progress in the right direction. She says that the 2020 report was at a time when RBI had still not joined Network for Greening the Financial Systems (NGFS) and the bank was framing its response to its role in addressing climate change-related risks. RBI’s joining the NGFS in 2021 and the subsequent release of this report indicate progress in this direction, she noted. The NGFS is a group of central banks and supervisors willing, on a voluntary basis, to share best practices and contribute to the development of environment and climate risk management in the environment sector.

The regulators at Task Force on Sustainable Finance, including RBI, have deliberated extensively about the ways and means to scale up sustainable finance in India. Perhaps this consultation paper is the culmination of such deliberations and it reflects RBI’s focus on disclosures to bolster climate finance in the banking sector, she opines.

Lauding RBI’s move, head of India Programme Climate Bond Initiatives, Neha Kumar, said that the consultation paper is a significant first step with the focus on climate related micro-prudential changes and disclosures by the regulated entities. “It will, I hope, start building a better understanding of the knowledge and capacity gaps that need to be built along the way within the banking sector, and strengthen the knowhow with which RBI tackles and deploys the toolkit available to it for a system-wide impact,” she adds.

Labanya Prakash Jena, a Regional Climate Finance Adviser at The Commonwealth Secretariat terms the paper a big development. RBI’s own survey on commercial banks regarding their preparedness for climate risk is not very encouraging. This is the situation when the government has an ambitious plan to decarbonise the economy. It needs the mobilisation of huge capital but the capital providers are not ready. “This consultation paper has come a little late but beyond my expectation. We had a sense that RBI will come with regulations gradually but they have come with a slew of recommendations in one go. So, I think, it is a significant step,” he adds.

Financial risks related to climate

In its discussion paper, RBI has used several reports and examples to underline the increasing threat of climate change and related financial risks. For instance, referring to India Meteorological Department (IMD)’s report, it said that the frequency of natural disasters has increased sharply. Since 1900, the country has recorded a total of 756 instances of natural disasters. In the last century (from 1900 to 2000), the country has witnessed as many as 402 natural disasters. In comparison to this, a total of 354 such events have occurred just in the past two decades (2001-2021) – that means 88% of natural disasters in the last century have occurred in just 20 years.

“The uncertainty about the timing and severity of climate-related and environmental risk certainly threatens the safety, soundness and resilience of individual REs and, in turn, the stability of the overall financial system,” says the paper.

To discuss the strategy on climate change, the apex financial body of the country raises the first discussion point and asks about the immediate priorities in shaping the policy discourse on climate risk in India. It asks, “What actions would help foster a more sustainable and resilient financial system?”

Subsequent to this, the paper gets into the climate-related risks. As per it, the potential risks may arise from climate change or from efforts to mitigate climate change. It classifies risks into two categories – physical and transition risks. Physical risks include the direct impact of extreme climate change-related weather events, long-term gradual shifts of the climate like rising sea level or average temperature and also loss of ecosystem services etc, the RBI paper explains. Similarly, there are some transitional risks that arise from the process of adjustment towards a low-carbon economy.

Here, it raises a second discussion point, “What should be the way forward for the regulatory policy framework for climate risk in an emerging market like India keeping in view its aspects such as demography, geography, etc.?” Here, the central bank goes on asking REs whether they are contemplating including climate and environmental considerations in their core activities of lending and investment.

Other than these points, RBI put forth four points including the main challenges in integrating the climate risks framework in governance, the overall timeline for implementation of the disclosure/TCFD framework and the role of RBI with respect to climate risk and sustainable finance. 

When asked whether the discussion paper covers all the aspects of the challenges looming large on India’s financial system, Suranjali Tandon says, “While the paper covers many issues with regard to disclosures, I think it shows that the RBI is willing to introduce changes to the banking system in a phased or calibrated manner. Disclosures are just one of the well-known ways to address climate change, we need to wait for RBI’s response to the comments received so as to understand the direction that it may choose to take in terms of the policy.” 

Kumar from Climate Bond Initiatives added that the paper seeks views on “what” to do, rather than on “how” to do at this stage for many of the proposals contained in the paper. “The Sustainable Finance Task Force set up by the Ministry of Finance (MoF) has put together a substantive draft report (Taxonomy and Sustainable Finance Roadmap) which awaits release and public consultations. The RBI and the MoF (and other regulators) will have to work very closely in putting the pieces right in the climate risks and sustainable finance jigsaw,” she adds.

Public Sector Banks lagging behind in preparedness 

Along with the discussion paper, the RBI also released a survey report underlining the preparedness of Indian banks regarding climate-related risks. It appears that the Public Sector Banks (PSBs) are least prepared as of now.

In the survey conducted in January, RBI included a total of 34 commercial banks including public sector banks, private sector banks, and foreign banks operating in India. It summarised its finding by saying, “although banks have begun taking steps in the area of climate risk and sustainable finance, there remains a need for concerted effort and further action in this regard.”

Beyond this general remark, PSBs were found lagging behind on almost all criteria like risk management, governance, climate-related financial disclosure, human resource-related capacity building, internal green initiatives etc. 

Taking the example of climate-related financial disclosure, all surveyed foreign banks are adhering to climate-related financial disclosure that too with the recommendations of the TCFD framework. Out of the total 16 private sector banks, three banks have aligned their climate-related financial disclosure to the TCFD framework. However, when it comes to PSBs, only few have recently started with making such disclosures but none of them are doing it as per the TCFD framework. 

When these banks were asked, in the survey, whether they are mobilising new capital or setting a target for incremental lending and investment for sustainable finance, most public and private sector banks said that they are yet to do so. It should be noted that any response to climate change will need intensive capital mobilisation. The RBI paper says, “Emerging markets need around $94.8 trillion to help them transition to a net-zero economy by 2060. India alone would need $17.77 trillion for the purpose.” 

Through the response of these 34 banks, it appears that almost all foreign banks and a few of the private sector banks had a separate department or business vertical for sustainable finance. But, PSBs have not taken any initiatives in this direction.

Almost all banks recognised the potential risks due to climate change, but the majority of the banks have not brought any strategy to manage this risk. In the survey, most of the foreign banks informed that they have an internal strategy to integrate climate risk into their risk management framework. But this is not the case with Indian banks. Only two out of the 12 public sector banks and four out of 16 private sector banks have any internal strategy in this regard. 

When it comes to quantifying the amount of the bank’s loan and an investment portfolio that is vulnerable to climate risks, just one out of 12 PSBs have attempted to do it. In comparison to this, five out of six foreign banks and five out of 16 private sector banks have put effort to quantify their portfolio that is susceptible to climate-related risks, according to the survey.

Responding to the question of whether banks have begun offering loans for green products such as rooftop solar, electric vehicles (EVs) etc, almost all the respondents said they had introduced such products. Similarly, a majority of banks including seven out of 12 public sector banks intend to initiate discussions with their large corporate borrowers about their plans to reduce their carbon emissions.

Regarding efforts to decrease the absolute carbon emissions arising from its operations, one out of 12 public sector banks and two out of 16 private sector banks also announced time-bound plans to become carbon-neutral.

About PSBs lacklustre approach, Tandon of NIPFP says, “Public sector banks confront many challenges including stressed assets, and at the moment the adoption of policies with regard to climate-related risks is voluntary. Therefore, it is reasonable to expect that the banking system is not well-prepared. There is a need to build awareness about the material impact climate-related risks will have on bank balance sheets. I think for this issue to be taken more seriously, there needs to be guidance not just on reporting risks but also the follow-on action in terms of sectors to which loans may be encouraged and where the flow of credit may have to be carefully tapered.”

Connecting RBI’s discussion paper and this survey, Neha Kumar says, the banking sector would look for a level playing field and a standardisation of definitions (taxonomy for sustainable activities) too which could guide them to pursue credible transition plans to manage risks and steer capital reallocation to green resilient activities. The current preparedness levels are low and intensive engagement with banks is a must, with a view also for them to work together with their clients in the real economy to shift capital at the pace and scale needed.

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Banner image: Reserve Bank of India, Regional branch in Kolkata. Photo by Kolkatan/Wikimedia Commons