MC Explains| Here’s what RBI's new approach on climate risk and sustainable finance means

The Reserve Bank of India (RBI) in its monetary policy committee (MPC) meeting on February 8 announced measures for climate risk and sustainable finance for regulated entities.

Explaining this, RBI Governor Shaktikanta Das said based on the feedback received from the central bank’s discussion paper on climate risk and sustainable finance in July 2022, it has released three measures: a broad framework for acceptance of green deposits, disclosure framework on climate-related financial risks and lastly, guidance on climate scenario analysis and stress testing.

Regulated entities, which include all banks, non-banking financial companies (NBFCs) and other financial institutions (FIs), are expected to design operations and products like deposit schemes, bonds, etc., in line with the guidelines, the RBI said.

But what would these measures and proposed guidelines mean for these entities?

Here’s an explainer:

The RBI talked about green deposits, what are those?

Green deposits are fixed-term deposits that primarily focus on environment-friendly projects. These deposits attract investors, who want to park their funds in projects and initiatives focusing on ESG or environmental, social and governance objectives.

The idea behind green deposits is that banks lend money to support ESG projects. The funds collected from green deposit schemes are mainly used to fund projects that fall under the United Nations Sustainable Development Goals (SDGs).

Do Indian banks have any green deposit schemes?

In India, a number of banks like Federal Bank, HDFC Bank, IndusInd Bank, etc., have green deposit schemes which provide an interest rate of between 5 percent and 6.75 percent.

What about the climate-related risk factor?

Secondly, the RBI proposed to launch a disclosure framework on climate-related financial risks. The apex bank in its discussion paper on climate risk and sustainable finance in July 2022 recognised credit, market, liquidity and operational risks as climate-related financial risks for regulated entities.

What are banks supposed to do now?

With respect to the actions to be taken by banks and other FIs on climate-related financial risks, RBI Deputy Governor M Rajeshwar Rao in December 2022 said banks would need to work on improving the management of financial risks in their books which may originate from climate change.

“Such risks range from the direct physical risks emanating from adverse climate-related events to loss of reputation and legal risks,” Rao said.

For the measures introduced by the MPC, the central bank said guidelines on them will be issued in a phased manner. It added that a dedicated webpage will be created on its website which will consolidate all instructions, press releases, publications, speeches and related RBI communication on climate risk and sustainable finance.

Lastly, RBI announced guidance on climate scenario analysis and stress testing for regulated entities.

“Scenario analysis may also be used to explore the sensitivities in longer-term business plans. As part of capital planning, REs would have to assess their capital adequacy based on scenario analysis,” the paper suggested.
Reducing carbon intensity, lowering dependence on fossil fuels for electricity, carbon sink expansion target, etc., were other suggestions proposed by the RBI.

What could these measures mean for companies?

For institutions to work on the proposed measures concerning green banking and sustainable finance, they would have to adapt to some physical, transitional and financial operations, experts said.

Karan Gupta, banking analyst, India Ratings & Research, Fitch Group, said that banks can work on pushing the methodology to issue green bonds to investors.

“The concept of green banking is evolving. One thing that banks can work on is more green bonds but it also depends on the metrics,” Gupta said.

Suranjali Tandon, assistant professor at the National Institute of Public Finance and Policy highlighted how banks and other FIs can lend more to green projects.

“Banks already have green funding as a part of their priority sector lending. In line with the RBI guidelines, one can expect them to infuse more funding in these projects,” Tandon said.

Other than measures in areas concerning lending, regulated entities also need to recheck their portfolio and work on climate-related financial disclosures. These disclosures are not mandatory for now, Tandon said, but can help banks align their portfolio better towards green financing.

Gupta said that digital lending could be boosted to marginally reduce banks’ carbon footprint.