How RBI can prepare for climate-related risk management – Economic Times | Region & Cash

Last week, Shaktikanta Das announced that the Reserve Bank of India (RBI) “will issue a discussion paper on climate change and climate change-related risks,” adding, “The increased demands for corporate and industrial financing to combat climate change are heavily influenced by the global development of climate-related risk management.’

So how can RBI prepare for this clear and present danger? One set of tools are scenario analyzes and stress tests of the banking system. Recently, the European Central Bank (ECB) conducted its first climate test with startling results: A sudden increase in carbon prices combined with floods and droughts this year would result in losses of at least $71.1 billion for the eurozone’s largest banks.

Other central banks, including those of France, China, Malaysia and Japan, have also conducted or plan to conduct scenario analysis and stress tests to assess the resilience of their financial systems to climate risks. It’s time for RBI to take the baton too.


source of financial risk

Climate risk interacts with and amplifies the traditional risks facing banks – credit, liquidity, operational and reputational risk. For example, lending to the thermal power generation sector involves significant credit risk. This is because higher carbon taxes, demand substitution with lower emission options, higher commodity costs and lower availability of capital lead to higher counterparty default probabilities.

Several imported coal-fired power plants in India are located in or near coastal areas. These are vulnerable to the physical risks of climate change from sea level rise and the increasing severity of extreme weather events such as cyclones and floods. This, in turn, is a potential source of credit risk for banks lending to such assets.

Climate-Related Disclosure Framework

A prerequisite for conducting such supervisory exercises is the collection of climate-related data from financial institutions for risk identification and measurement. Mandatory climate-related disclosures are becoming a reality. Some of these disclosure requirements align with the Task Force on Climate-Related Financial Disclosures (TCFD).

Last year, the G7 committed to making TCFD reporting mandatory. Countries such as New Zealand, Japan, Malaysia and the UK mandate TCFD-aligned or TCFD-inspired climate claims. The TCFD framework has four thematic areas: (1) Governance, (2) Strategy, (3) Risk Management, and (4) Metrics and Goals. For example, under (2) organizations must disclose the resilience of their strategy to a 2°C or lower scenario. TCFD provides supplementary guidance for banks and other financial institutions in these four areas.

Use global experience
TCFD is endorsed by 110 financial regulators, including 50 central bankers, and 2,600 organizations worldwide follow its regulations. There are several lessons to be learned from this for Indian banks. RBI is also part of the Network for Greening the Financial System (NGFS), a group of 114 central banks and financial regulators aiming to share best practices that contribute to the development of environmental and climate risk management in the financial sector.

NGFS has developed four standardized climate scenarios that central banks can use as a starting point. RBI can learn from other central banks that have already conducted climate tests with scenarios from NGFS and disclosures according to TCFD.

Obligation to disclose climate data for banks
India has already introduced a sustainability disclosure standard: Business Responsibility and Sustainability Reporting (BRSR). While BRSR focuses on broader environmental, social and governance (ESG) disclosures, TCFD focuses on climate-related disclosures. BRSR also does not include scenario analysis, an important part of TCFD. Better coordination between the RBI and the Securities and Exchange Board of India (Sebi) can help mandate climate-related disclosures for banks as part of their BRSR disclosures.

TCFD-compliant disclosure by banks will not only benefit RBI, but also other stakeholders, such as e.g. B. Investors, provide data points to assess a bank’s reputation from a climate risk perspective. It will also help banks take climate risks into account when lending and introduce green financial products to de-risk their loan books. This will increase uptake of green credit and finance for low-carbon activities and help India meet its climate goals.

The step-by-step implementation of TCFD was not easy for banks

According to a May 2021 KPMG survey of TCFD disclosures from 25 global banks, scenario analysis is still evolving. Banks have yet to fully quantify the impact of climate change on their strategy.

Companies struggle to collect, compile and analyze detailed emissions-related data across all aspects of their operations. It becomes more difficult for banks when they have to disclose financed issues. Therefore, RBI should allow banks to phase out TCFD-aligned information to help them get used to the nuances of climate reporting and climate-related scenario analysis.

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