The takeaways from RBI paper on climate action
PremiumIt offers valuable insights and broad guidance on the role our financial sector can play in addressing the mitigation challenge
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. It diligently elucidates both (i) physical climate impact risks and (ii) 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.
Refreshingly, 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.
More emphasis could however have been laid on the numerous financing opportunities that our climate transition holds for regulated entities, considering the billion dollar investments required this decade itself, to hasten the buy-in of entities before any mandated targets kick in. Secondly, 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, which by reconditioning end-of-life products could reduce the use of non-renewable resources and wastage across agriculture and industry. Regulators need to pull out all stops to support financiers and avert the disconcerting possibility of overseas capital bypassing India Inc, given that developed economies are also competing for transition investment.
Six key questions have been raised in RBI’s paper. In this regard, implementation timelines and the prioritization of qualitative versus quantitative metrics are crucial.
Fast warming ocean and land temperatures, extreme flooding or drought-like events that impact water availability and soil quality, and India’s 2021 ranking among the ten worst affected countries by an important climate risk index call for quick action by India Inc and its financiers.
To enable regulated entities to proactively manage the uncertain timing and severity of climate risk challenges and to support our net zero goal, it will be prudent to swiftly incorporate both qualitative and quantitative aspects upfront, simultaneously. Such implementation should be done concurrently across different parameters, with metrics tightened progressively in phases.
Nevertheless, RBI must tread carefully by taking a balanced approach, considering that banks and other regulated entities are already saddled with multiple capital commitments, liquidity buffer burdens, cash reserve requirements, priority sector lending (PSL) targets, corporate social responsibility obligations and possibly future green energy usage government mandates. Yet, any goal without numerical targets would not move the needle and would only be beating around the bush. Therefore, a tough act of jugglery confronts regulators.
Qualitative issues: (a) 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. (b) 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. (c) Regulators may also ask regulated entities to strengthen capital buffers or incentivize climate-positive sectors through lower risk capital weightages.
MINT PREMIUM See All
Quantitative metrics: (a) Sector and region-wise concentration needs progressive rationalization. (b) To achieve quantum reductions in Scope 1 and Scope 2 emissions from regulated entities’ own operations, investments should be incentivized to reduce their carbon footprint by using 24x7 renewable energy based on storage batteries, plus other transition capital expenditure to lower that footprint across data centres—rightly referred to as new-age factories that include various service centres as well as corporate offices. (c) 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 by lowering annual exposure to complacent polluter industries and prioritizing lending to energy efficient cooling technology providers, given expectations of extreme heat wave events in times ahead. This gets merged under Scope 3 emission reductions, implemented phase wise. (d) 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). If climate financing is made a sub-category under 40% PSL targets, a better balance can be achieved between directed lending provisions, fostering a green economy and ensuring the expeditious operationalization of RBI’s climate action initiatives. As an enabler, and given that overseas financing of the country’s climate transition is especially welcome in times of currency volatility, a mechanism to consider specific foreign currency exposures within the scope of adjusted net bank credit and PSL computations may also be appropriately devised by bankers. (e)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.
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.
Ashiesh Kapoor is a corporate banker and author of ‘Singapore Holiday Travelogue’.
Catch all the Business News, Market News, Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates.
More Less