Moneycontrol PRO
Open App
you are here: HomeNewsOpinion

Green is the new colour of Indian Banking 

While Indian banks are aware of the risks they face because of climate change, they are not prepared for the same

August 12, 2022 / 01:52 PM IST
Representative image

Representative image

Climate change — and its associated risks — has become one of the most pressing challenges facing humanity. Climate scientists and governments are exploring the impact of climate change on lives and livelihoods.

Amidst the various discussions, concerns are being voiced that climate change will impact the banking sector adversely and spread the risks to the entire financial system. The Financial stability board (FSB) has released guidelines to safeguard banks from these risks. Central banks and financial regulators have established the Network for Greening the Financial System (NGFS), which has 116 members and 19 observers. Central banks are also busy researching the various issues pertaining to climate change in their respective jurisdictions.

Taking a cue from all the attention on climate change, the Reserve Bank of India (RBI) released a discussion paper on Climate Risk and Sustainable Finance in the last week of July. The purpose of the discussion paper was to suggest ‘an appropriate governance structure and a strategic framework’ to RBI-Regulated entities (RE) for managing and addressing risks related to climate change. The RBI also released a survey showing how leading scheduled commercial banks are currently managing financial risks related to climate change.

The RBI discussion paper points to two major risks facing the banking system due to climate change: physical risks and transition risks. Physical risks are financial losses resulting from the increasing frequency and severity of natural disasters (earthquakes, floods etc.), long-term risks of climate change (rising sea levels, ocean acidification, etc.), and the indirect effects of these (water shortage, soil degradation, etc.).

Transition risks refers to risks arising from adjustments to a low-carbon economy. As businesses shift from traditional forms of energy to greener sources, there could be an initial decline in production, and even in the quality of goods. This could lead to problems for banks which have lent to such firms. The banks themselves will face risks while transiting to greener investments and loans.

Close

The banks have to analyse and understand how the twin climate change-related risks will add to prudential risks inherent in the banking system – credit risk, market risk, liquidity risk, and operational risk. Extreme weather events can derail manufacturing, posing higher credit and operational risk.

As investors move towards greener investments, they face liquidity and marketability risks pertaining to these investments.

While we know these risks will materialise in the future, their timing and scale is highly uncertain. So banks will have to engage and estimate future climate risks in a continuous manner. While banks have always been estimating future financial risks, they will now also have to estimate climate risks and its impact on the banking / financial system. This will not be easy.

How are India’s banks doing on the climate assessment front? RBI’s survey throws light on this question. The survey looks at broad areas of risk management, governance, climate-related financial disclosures (CRFD)m and opportunities from transition to a green future.

On risk management, nine out of 12 public sector banks (PSB) and 14 of 16 private sector banks  considered physical and transition risks as sources of climate-related risks.

However, only two of 12 PSBs and four out of 16 private banks have put in place a strategy for managing climate risk and integrating it into their risk management framework. Foreign banks not only assess these risks but have also put in a framework for the same. In terms of personnel, most banks have people who understand the risks but lack data to estimate the same. Most public and private banks have not conducted awareness programs among their employees.

On governance, the survey shows that the board of directors has discussed the need to raise awareness on climate-related financial risks in four PSBs and nine private banks. In most of these banks, there is no clarity on who oversees climate-related matters.

On CRFD, no PSB has made any disclosure related to climate change, whereas three of 16 private banks have started making climate-related disclosures. Six private banks have a separate web page on CRFD, but none of the PSBs do.

On the strategy for a green future, very few private banks and no PSBs have a dedicated department for sustainable finance. In terms of green financial products, nine PSBs and five private banks have introduced green deposit / loan products. All banks have introduced loans for green products like rooftop solar cells, electric vehicles (EVs), EV charging infrastructure, etc.

The survey summarises that while banks in India do understand the risks, they need to be prepared for the same. Change has to begin at the top, with the board of directors and senior management preparing a strategy for assessing and understanding climate change. The banks need to establish dedicated climate change departments with people drawn from multiple disciplines, and conduct awareness programs for employees.

By releasing the discussion paper and survey, RBI has encouraged greening of the banking system. The banks should take the risks posed by climate change seriously and do their bit towards the greening of the economy. Indeed, green should be the new colour of Indian banking.

Views are personal and do not represent the stand of this publication.
Amol Agrawal is faculty at Ahmedabad University.
Sections
ISO 27001 - BSI Assurance Mark