Financing for climate change needs non-conventional approach

In India the failure to comply with climate change-related obligations under corporate laws and environmental laws might invite claims against the company and its directors. (Representative image)

India is progressing fast towards meeting its commitment to Net Zero by 2070. The capacity for the generation of renewable energy has increased by 400 percent over the last 10 years to 174 GW in January 2023 and the share of renewable energy in the energy mix has increased to more than 40 percent. The budget for 2023-24 further announced programmes for green fuel, green energy, green farming, green mobility, green buildings, and green equipment, as also policies for the efficient use of energy.

The allocation for the Ministry of Environment and Climate was increased by about 24 percent and the National Green Hydrogen Mission has been given a boost with an outlay of Rs 19,700 crore. All these and many more initiatives will greatly enhance the country’s preparedness to meet its commitments and provide vast opportunities for investment in areas such creation of renewable energy capacity, technology and manufacturing of equipment, storage, and transmission facilities.

While the government has taken wide-ranging policy decisions and structural initiatives, the banks and financial institutions (BFIs) have a key role in the transition towards Net Zero and India assuming a leadership role. As per Council for Energy Environment and Water (CEEW), a total investment of $10.1 trillion would be needed to meet India’s net zero commitments by 2070.

Learn From Past Mistakes

Banks and financial institutions have to strategise for the mobilisation of resources domestically and internationally. They have to also gear themselves to channelise the funding to carbon-efficient sectors and as transition finance for businesses to adopt cleaner technologies and increase energy efficiency.

Learning from the experience of financing renewable power projects, access to timely finance on concessional terms compatible with techno-economic characteristics of transition risks assumes importance. For example, in the initial phase of solar power development, high interest rates, lower repayment period and equated repayment schedules instead of ballooning towards the end crippled their viability. Similarly, the transition to carbon-efficient technology needs concessional support to remain competitive in the market. Projects with high technology risk such as EV or energy storage may have lower payback periods and therefore need commensurate fiscal and non-fiscal support.

Recognise The Risks

Having said that, amidst the frenzy for climate finance, BFIs should avoid reckless funding risking their balance sheet. Climate-related risks range from the direct physical risks emanating from adverse climate-related events such as landslides and floods, indirect effects such as desertification and water shortage, to loss of reputation and legal risks. Recently, three French NGOs took BNP Paribas to the court, in the world’s first climate lawsuit against a commercial bank, and urged the bank to stop financing fossil fuel-based projects. The European Commercial Bank (ECB) has also warned the European banks that if they do not meet the targets they have announced or follow the climate strategy they have communicated, they would expose themselves to litigation and reputational risks.

In India as well the failure to comply with climate change-related obligations under corporate laws and environmental laws might invite claims against the company and its directors. Norway’s sovereign wealth fund, the world’s single largest investor, has warned the directors of companies it is invested in to step up setting targets and actions for achieving net zero [emissions] by 2050.

Lending for climate change and protecting their portfolio from climate-related risks by BFIs is a different ball game. BFIs need to integrate, with high weightage, environmental and social risks into their credit risk assessment metrics, appraisal mechanisms and monitoring mechanisms. The current practice of considering these as one of many factors may not suffice. Estimating the timing, frequency and severity of climate-related risks, and implications thereof, for example, floods in Uttarakhand, earthquakes in Turkey or prolonged war in Ukraine, is a challenging proposition. Yet, the banks should focus on capacity building, creating related databases, deploying suitable tools for scenario or sensitivity analysis and stress testing their portfolio. SEBI and RBI have laid out climate-related disclosure mechanisms. They should now create a taxonomy and made third-party assurance mandatory for the top 1,000 listed entities for proper risk assessment while lending.

In conclusion, BFIs need transformational change, end to end, in their lending strategy, policy and organisational set-up in arranging for the transition finance required by the businesses. Lest they run the risk of endangering their balance sheet as it happened due to imprudent lending to thermal power projects.

Ashok Haldia is former secretary of Institute of Chartered Accountants of India. Views are personal, and do not represent the stand of this publication.