Indian banks take initial steps to address climate financial risks—now they must accelerate

How prepared are Indian banks to tackle climate-related risks? Well, the journey has just begun with the generation of data of risks posed by climate change, and offerings like green bonds and green fixed deposits. Still, the bottom line is that banks need to hasten their actions to mitigate climate-related risks to their operations.

An assessment of 34 major Indian banks with a combined market capitalisation of `29.5 lakh crore in FY22 found that India’s public sector banks are more exposed to climate risk than their private rivals. That’s because they are major lenders to the energy (conventional), mining, and metal sectors. Climate Risk Horizons (CRH), a think tank working with financial institutions to prepare them for climate-related risks, released the biennial assessment in August 2023, the second in the series.

On a positive note, Indian banks have started prioritising lending to green projects through special products; some are measuring the emissions of projects they have financed, developing tools and assessment frameworks for climate risks in their portfolio, and considering a policy to exclude carbon-intensive projects.

But is that enough?

Rama Patel, Senior Director and Chief Ratings Officer at CRISIL ESG Ratings and Analytics Ltd, says banks are beginning to take steps to address climate-change risks, and integrating them into operations will help banks contribute to building a more sustainable and resilient financial sector in India.

For their part, financial sector regulators, too, have made climate risk assessment a priority. The Reserve Bank of India (RBI) introduced a draft disclosure framework on Climate-related Financial Risks, 2024, in February that applies to all entities regulated by it.

“The central bank has provided a glide path for regulated entities to meet the disclosure requirements. Indian banks are at a nascent stage of assessing, disclosing, and addressing climate-related risks. The process will require banks to gather climate-related disclosure across their portfolios from both transition risk and physical risk perspectives,” Patel says.

For banks, climate risk still doesn’t fall under the mandatory regulations.

Going back to that CRH analysis, YES Bank topped the assessment with a score of 15 on a scale of 20, followed by HDFC Bank and Axis Bank, both of whom scored 13.

YES Bank says it has set up a dedicated sustainable finance unit with employees who have specialised knowledge and experience in environmental management, carbon accounting, and climate risk. The unit works with teams across the bank, industry peers, think tanks, and other external stakeholders to keep abreast of the latest methodologies and protocols and learn about the best practices.

“The bank has also adopted an environment and social policy (ESP) as a structured approach towards responsible lending and to integrate environmental and social risks as part of its overall credit risk assessment framework,” Niranjan Banodkar, Group CFO of YES Bank, tells BT.

Other banks are also taking similar measures. Federal Bank and Suryoday Small Finance Bank have a policy commitment to restrict or end coal financing. Kotak Mahindra Bank and RBL Bank have begun institutionalising tools and assessment frameworks for climate risk. The majority of the banks have begun lending to renewable energy projects; they have also introduced schemes for electric vehicles, rooftop solar installations, and battery storage.

However, for many regulated entities, data generation remains the biggest challenge.

CRISIL’s Patel says financial implications arising out of climate risk can be calculated through stress tests based on scenarios designed by the Network for Greening the Financial System—a network of central banks and financial supervisors—and formulating strategies to minimise the impact.

“Further, regulated entities have to analyse their exposure to environmentally sensitive sectors from a transition risk perspective. While banks have started to act on some of these aspects, disclosures related to climate risk—including around financed emissions—need to evolve,” she adds.

Several financial consulting firms are working with banks to help build capacity by conducting climate risk assessment training.

Financing holds the key to transitioning to green sectors, and banks can play a pivotal role in mobilising resources for green projects.

One method that has gained traction is ‘green deposit’—an interest-bearing deposit, for a fixed period, the proceeds of which are earmarked for green financing.

The RBI issued a Framework for Acceptance of Green Deposits that came into effect on June 1, 2023. It aims to direct the flow of funds to sustainable projects and initiatives, protect the interests of depositors, and address greenwashing concerns.

Most scheduled banks offer this facility now.

Sagar Asapur, Head of Sustainable Finance at CRH India, says the RBI’s framework offers banks the chance to contribute significantly to climate risk mitigation and adaptation projects. However, the scheme also has significant challenges and shortcomings that need to be addressed.

First, the absence of a definitive taxonomy is leading to ambiguity in determining what a “green investment” is.

“This will inevitably lead to greenwashing and be counterproductive. Second, strong transparency and disclosure requirements for banks around green deposits are needed to enable independent public verification of all investments. Some banks offering green deposit schemes have not provided necessary disclosures, making it challenging for depositors to assess the true environmental impact of their investments,” Asapur tells BT.

Clearly, incorporating climate risk assessment into key financial decisions is going to be a long journey for banks. It is one they need to accelerate.

@richajourno