RBI Suggests Ways To Deal With Climate Change For Banks

The Reserve Bank of India (RBI) has issued a discussion paper for banks and financial institutions on climate risk and sustainable finance. The apex bank has suggested ways to cope with risks arising from climate change. Banks and financial entities can give their comments on the recommendations by September 30, the central bank said in a press release.

The RBI has suggested banks to formulate and implement policies at board level to identify and price-in risk while dealing with their customers, and also to maintain their operational continuity. The central bank has proposed that banks should make necessary disclosures to notify stakeholders and regulators of their exposure to such risks.

Some of the major risks for banks identified by the RBI due to extreme weather changes include devaluation of assets held as collateral, borrowing entities becoming insolvent, sudden demand of liquidity, change in market preferences, and operations of financial institutions being disrupted.

Prescribing training sessions for bankers, it has suggested that the board of directors should form committees to tackle climate-related financial risks and also sensitise senior management to such threats.

The Indian Banks’ Association (IBA) can set up a working group to that effect or banks can also tie-up with institutions such as the International Finance Corporation (IFC).

RBI governor Shaktikanta Das has recently said the objective of the central bank is not to compromise growth while prioritising climate-related risks. The RBI is looking to go ahead with the climate change issue in a collaborative manner, without being too prescriptive, he added.

The risk monitoring practices that banks need to put in place before issuing loans to borrowers vulnerable to extreme climate risks include placing a cap on loan repayment tenure, adjusting loan limits where collateral is in real estate, providing insurance to avoid losses arising out of impact on production and supply chain and demanding energy transition plan from sectors with heavy carbon footprint.

 “Regulated entities (RE) may carry out substantial measures to mitigate or refrain from climate-related risks that are not in accordance with their risk appetite,” the RBI said in the consultation paper.

While estimating the short- and long-term investment cycles by businesses, banks should also consider climate change and policies undertaken by the government as factors, which will impact such investment decisions. In order to prevent banks’ operational disruptions arising out of such threats, lenders can distribute critical functions geographically.

They should disclose the significance of climate change on their operations and the material impact of their financial exposure to suck risks. Such disclosures can be made annually at an initial stage while taking guidance from the framework developed by an organ of the Financial Stability Board — an international body formed after G20 summit in London.

 “Adapting the same would also help improve the consistency and comparability of the climate-related financial disclosures of the REs with their counterparts globally,” the RBI said.

Survey on Climate Risk and Sustainable Finance

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 six 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.

Key Observations From The Survey

Board-level engagement and responsibility: Board-level engagement on climate risk and sustainable finance is inadequate. In about a third of the banks that were surveyed, responsibility for overseeing initiatives related to climate risk and sustainability was yet to be assigned.

Strategy: A majority of the banks did not have a separate business unit or vertical for sustainability and ESG-related initiatives. Only a few banks had a strategy for embedding ESG principles in their business, scaling up their sustainable finance portfolio and incorporating climate change risks into their existing risk management framework.

Risk management: Almost all the surveyed banks recognised the urgency of the issue, and most of them considered climate-related financial risks to be a material threat to their business. Physical and transition risks were seen as the main sources of climate-related risks

Transition to low-carbon exposure: Most of the surveyed banks have decided to gradually reduce their exposure to high-carbon emitting or polluting businesses in the coming years. A few banks have either mobilised new capital to scale up green lending and investment or set a target for incremental lending and investment for sustainable finance.

Climate-related financial disclosures: A majority of the banks have not aligned their climate-related financial disclosures with any internationally accepted framework.

Capacity building and data gaps: Most banks are looking at capacity building to better understand the financial implications of climate risk. Further, most banks felt that the available data was insufficient for an appropriate assessment of climate-related financial risks and the processes and methodologies to measure and monitor climate-related financial risks were also not sufficiently developed.