Need for policy framework to assess climate risk on financial stability: RBI
Premium- RBI has also called for a cross-industry disciplinary forum to launch a comprehensive climate risk assessment exercise for India
Mumbai: The climate change risk to financial stability is rising and there is a need for an appropriate policy framework to identify, assess and manage this risk, according to Reserve bank of India. In it’s financial stability report, RBI said that some central banks have started to prepare to monitor and manage climate risks.
The Bank of England for instance has announced plans to undertake Biennial Scenario analysis in order to test the resilience of the financial system to the physical and transition risks associated with different climate pathways. Banque de France has also started taking into account the high-level scenarios given by the Central Banks and Supervisors Network for Greening the Financial System (NGFS). Launched at the Paris One Planet Summit on December 2017, the NGFS is a group of central banks and supervisors willing to share best practices and contribute to the development of environment and climate risk management in the financial sector, while mobilising mainstream finance to support the transition towards a sustainable economy. RBI joined NGFS as a member central bank in April 2021.
RBI has also called for a crossindustry disciplinary forum to launch a comprehensive climate risk assessment exercise for India. As a prerequisite, India needs to develop emission reduction pathways for energy intensive sectors and map them onto macroeconomic and financial variables and integrate them with quantitative climate risk related disclosures to develop a holistic approach to addressing the financial stability risks arising out of climate change.
According to Emkay Research, this possibly indicates the need for a comprehensive Environmental Social & Governance policy framework in the long run, adding to the cost of doing business. Indian banks’ lending portfolio (mainly corporate sectors such as power, infra, metals, auto and chemicals/paper; vehicle in retail) remains vulnerable to growth/asset quality risks from climate change in the long run, and thus it needs to be addressed, it said.
According to the FSR report, climate risk stress tests are different from the traditional regulatory stress-testing framework in terms of time horizon, reporting frequency, sectoral specificity, modelling approach and nature of output. The attempts to quantify climate risks to the financial system can take two forms – top down and bottom up. Under a top down approach, the magnitude of risks can be estimated by using the sensitivity of exposures of the banking system to physical risk based on geography and transition risk mostly based on carbon emissions of the sector. In the alternative bottom up approach, financial institutions themselves compute the impact of climate risk on their respective portfolios based on a common scenario specified by the central bank.
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