Challenges in making Indian finance climate-resilient

Climate-related financial risks include those that may arise from climate change or efforts to mitigate climate change, their related impacts and financial consequences.
Challenges in making Indian finance climate-resilient
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All parts of the economy, including the financial sector, are vulnerable to climate risks. A UN report says direct economic losses due to disasters increased from around $895-1,313 billion (at 2017 dollar values) in 1978-1997 to almost $3 trillion during 1998-2017. About 90 percent of total losses from all disasters are climate related. Munich RE, a German reinsurance agency that compiles global disaster statistics, estimated global losses due to disasters in 2023 at around $250 billion, of which only 38 percent was insured.

Recognising the vulnerability of the global financial system to the risks posed by climate change, the Basel Committee on Banking Supervision (BCBS) of the Switzerland-based Bank for International Settlements (BIS), of which the Reserve Bank of India (RBI) is an institutional member, released a document in March 2024 emphasising the need for a holistic approach to address climate-related financial risks.

Recognising the importance of securing India’s financial sector from climate risks, the RBI circulated a ‘Draft Disclosure Framework on Climate-related Financial Risks, 2024’ for implementation by regulated entities (REs) in India that includes all scheduled commercial banks excluding local area banks, payment banks and regional rural banks, all Tier-IV primary urban co-operative banks, all-India financial institutions such as Exim Bank, NABARD, and all top non-banking financial companies.

Climate-related financial risks include those that may arise from climate change or efforts to mitigate climate change, their related impacts and financial consequences. The REs mentioned above are expected to build capacity to manage climate-related risks and benefit from climate-related opportunities, including responding and adapting to physical and transition risks.

The BCBS and RBI documents list various types of climate-related financial risks, including physical risks that are economic and financial losses due to disasters caused by extreme weather events such as floods, drought, extreme temperatures, adaptation to climate change, and indirect costs such as loss of ecosystem services. Transition risk refers to costs arising from shifting to a low carbon economy such as phasing out fossil fuels and shifting to renewables, availability of efficient new technologies, and change in consumer preferences and behaviour such as shifting to sustainable diets. An RBI discussion paper, ‘Climate Risks and Sustainable Finance’, states that a disclosure should address credit, market, liquidity and operational risks.

The document sets out four pillars for disclosure covering governance, strategy, risk management, and targets and metrics.  It assigns a major responsibility to governing bodies of REs who are required to identify, assess, manage, mitigate, monitor and oversee climate-related financial risks and opportunities in the near and long term. They also need to identify and spell out their strategy to address climate-related financial risks and risk management policies. Further, they should fix targets and reveal the metrics or indicators to assess the progress in achieving these targets.

The RBI’s draft disclosure framework elicited mixed responses from banking and financial circles. While its attempts to make India’s financial sector climate-resilient is laudable, there are a few concerns. Do boards and senior management of banks and other institutions have the requisite skills and expertise to assess climate risks and strategies to manage them? For this, they need experts with skills in scenario planning and modelling of plausible climate futures and risks, and knowledge about climate science and economics.

REs are required to make the disclosure along with their annual reports at the end of the financial year. However, industry bodies such as the Asian Security Industry and Financial Markets Association have expressed reservations, as it places undue burden on bank managements at a time when they are busy preparing annual reports; they suggested a different timeline for disclosure. The framework treats climate-related risks as a standalone risk, rather than as a driver of traditional risk types as per global and BCBS standards.

The RBI proposal gives the discretion to banks and other REs to determine the targets and metrics to assess the progress towards making them climate-resilient. It advises them to refer to global resources such as the UN Environment Programme’s Finance Initiative, Glasgow Financial Alliance for Net Zero to fix the targets and metrics. As the central bank, the RBI could have played a major role by consulting stakeholders and identifying measurable indicators to be used by the REs to assess progress in their climate risk disclosure. This would enable a common framework and metrics to assess the progress in making India’s financial sector climate-resilient. The RBI could provide a ready reckoner to banks to estimate greenhouse gas emissions by activities or assets.

Under metrics and targets, RBI proposal lists some requirements too difficult to measure—such as whether and how climate-related considerations are factored into remuneration of whole-time directors and CEOs. Can the RBI tell us what proportion of its governor’s remuneration is climate-related? It refers to climate-related issues in the draft but does not define this. Does the framework meet objectives of corporate disclosure or prudential disclosure?

The RBI’s framework needs a relook. The central bank needs to provide a detailed set of measurable indicators to enable the REs to have a common yardstick to assess progress towards making India’s financial sector climate-resilient.

K N Ninan

Lead author, GEO-7, UN Environment Programme, Nairobi

(Views are personal)

(ninankn@yahoo.co.in)

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