Making The Indian Banking Climate Risk Resilient
The Reserve Bank of India's (RBI) draft guidelines on climate risk disclosures represent a significant step toward aligning the Indian banking system with international standards concerning climate risk regulation. These guidelines are set to apply to a wide array of financial institutions, including scheduled commercial banks, top and upper layer non-banking financial companies (NBFCs), large urban cooperative banks (UCBs), and foreign banks, collectively referred to here as "banks."
Unlike the existing Sebi Business Responsibility and Sustainability Reporting (BRSR) guidelines, which encompass a broad range of Environmental, Social, and Governance (ESG) compliance issues, including direct emissions, the RBI's focus is sharply on the climate risks emanating from a bank's lending and investment portfolio. The spotlight is on the 'Environmental' component of ESG, particularly on 'financed emissions'—emissions generated by the projects and companies banks invest in or lend to, which account for over 90 per cent of a banking entity's total emissions.
The need for the guidelines
The necessity for these guidelines stems from the desire to bring bank disclosures in India up to par with global standards, such as those in the UK, EU, Canada, and Australia. These international standards not only demand banks to manage climate risks effectively but also differentiate between physical risks (e.g., extreme weather events) and transition risks (e.g., policy changes, technological shifts).
India, prone to climate-induced catastrophes like heatwaves, floods, and droughts, faces significant physical risks. These events can adversely affect the financial stability of banks' borrowers and diminish the value of bank investments.
In addition, sectors with high carbon intensity, such as power, cement, and steel, which receive a substantial portion of industrial credit, are particularly vulnerable to transition risks. These include slower decarbonisation, restrictive trade policies, and competition from cleaner technologies. To support the transition to less carbon-intensive operations, substantial investment is required, estimated at around $160 billion annually until 2050.
As part of its commitment to achieving net-zero emissions by 2070, India relies on its banking and financial sector to play a crucial role. Banks would have to set a clear path toward reducing financed emissions, necessitating the establishment of short, medium, and long-term targets.
Compliance requirements for banks
Complying with the RBI's guidelines requires banks to undertake several steps. Initially, they must develop a comprehensive climate risk management framework, recognising climate risk as a material risk category (at par with material risks like Credit risk, liquidity risk etc). This framework should cover risk identification, assessment, measurement, and reporting, necessitating significant investment in capacity building (within risk departments and also in Senior Management & board) and technology.
Subsequently, banks are to set net-zero targets, aligning with India's Nationally Determined Contributions (NDCs) and the specific transition plans of various industries. This involves establishing a glide path for reducing financed emissions and identifying financing initiatives to meet net-zero goals.
Developing a robust capability for assessing and reporting financed emissions is crucial. Banks must accurately measure the emissions financed by their lending and investment activities, requiring detailed methodologies, extensive data collection, and advanced technological platforms.
Furthermore, banks must engage with their customers (especially corporate segment), assessing the physical and transition risks in their operations and offering innovative financing solutions for climate risk adaptation and mitigation.
Finally, integration with business and credit functions is essential. Banks need to innovate sustainable finance products and proactively address the climate financing needs of their customers, ensuring the alignment of lending practices with the broader goal of achieving net-zero emissions.
Ajay Sirikonda, Partner and Leader – Financial Services Risk Management, EY India
