Date: 14/09/2022

Relevance: GS-3: Indian Economy, environmental pollution and degradation, environmental impact assessment.

Key Phrases: Reserve Bank of India, Financial stability, Sustainable Finance Group, Climate risk discussion paper, Physical climate impact risks, Transition loss risks, Qualitative issues, Quantitative metrics, Decarbonization technologies, Sustainable financing, Climate transition certificates.

Why in News?

• RBI’s paper on climate action has suggestions worthy of adoption.

Background:

• As the regulator of banks, the Reserve Bank of India has a significant role to play in shaping how banks adapt to climate change.
• In recent years, the RBI has moved to acknowledge the risks climate change will pose to financial stability.
• In May 2021, it set up a Sustainable Finance Group within its Department of Regulation “to coordinate with other national and international agencies on issues relating to climate change”.
• The Reserve Bank also released on its website the results of a Survey on Climate Risk and Sustainable Finance undertaken in January 2022.
• The survey was carried out to assess the approach, level of preparedness and progress made by leading scheduled commercial banks in managing climate risk.
• The survey covered 12 public sector banks, 16 private sector banks and 6 foreign banks in India.
• It provides useful insights, and the feedback from this exercise will help in shaping the regulatory and supervisory approach of the RBI to climate risk and sustainable finance.
• In a bulletin issued in March 2022, the RBI analysed the impact of the green energy transition on fossil fuel dependent industries.
• The recently released climate risk discussion paper by the Reserve Bank of India (RBI), to encourage the country’s financial sector to prioritize green-transition financing and ensure long term systemic stability by addressing the growing threat of climate challenges, is most welcome.

Climate risk discussion paper by the Reserve Bank of India:

The paper highlights gaps in the way climate change as a material risk is treated by India’s banks. It diligently elucidates:

• Physical climate impact risks.
  • It refers to the economic costs and financial losses resulting from the increasing frequency and severity of extreme climate change-related weather events such as acute physical risks and chronic physical risks.
  • Physical risk impact depends on geographical locations, as different regions display varied climate patterns.
• Transition loss risks
  • Transition loss risks that further complicate the credit, concentration, operational, liquidity and market risks for regulated entities in the banking, financial services and insurance (BFSI) sectors.
  • The process of transition to reducing carbon emissions may have a significant impact on the economy. It includes:
    • Cost due to changes in climate-related policies and regulations.
    • Investment portfolios or reduction in cash flow due to emergence of newer technologies.
    • Shifting sentiments and behaviour of customers.

The consultation paper offers:

• Broad guidance,
• Illustrative examples and good practices for regulated entities around governance,
• Disclosures strategy, processes and the risk management structure to address climate risks, with valuable insights for consideration of boards.
• It provides more emphasis on the numerous financing opportunities. Ex. foreign capital for the promotion of environmentally sustainable business through sustainability-linked loans and bonds will require incentivization to aid the green transition from ‘Take-Make-Dispose’ linear economy models to a ‘Reuse-Reduce-Recycle’ circular economy model.

Issues need to be addressed:

• Qualitative issues:
  • Assimilating information on basic climate-impact parameters from corporates during the credit appraisal stage should be mandated, which in addition to helping regulated entity managements take informed lending or investment decisions, will over time also generate accurate data to help improve climate default risk forecasting models.
  • Due to the absence of qualitative data on climate change default probabilities, stress testing, forecasts or scenario analysis could be prescribed as a short-term proxy for loss estimates of lending and investment portfolios.
  • Regulators may also ask regulated entities to strengthen capital buffers or incentivize climate-positive sectors through lower risk capital weightages.
• Quantitative metrics:
  • Sector and region-wise concentration needs progressive rationalization.
  • To achieve quantum reductions in emissions from regulated entities’, operations, investments should be incentivized to reduce their carbon footprint by using 24x7 renewable energy based on storage batteries.
  • Besides mandating an increase in regulated entities’ share of loan/mergers and acquisition financing of newer decarbonization technologies, green hydrogen and renewable power generation, priority areas should include quantifiable reductions in verifiable greenhouse gas emissions.
  • For banks, there’s a need to incentivize sustainable financing via risk weight concessions and consider a realignment of PSL guidelines that already incorporate various ‘Environment’ and ‘Social’ bits of ESG obligations (in a haphazard way though).
  • To aid regulated entities that are temporarily short of targets, a mechanism for issuing climate transition certificates (CTCs) could be structured on the lines of carbon credits or PSL certificates.

Way forward:

• To conclude, corporates and regulated entities in India can beat the challenges of climate change if they embed sustainability at the core of their business strategy and manage transition implementation, tracking and reporting commitments proactively.

Sources: Live-Mint

Mains Question:

Q. What should be the immediate priorities in shaping the policy discourse on climate risk in India? What actions would help foster a more sustainable and resilient financial system? [250 Words].