Climate-related financial risk disclosure framework

The draft guidelines issued by the Reserve Bank of India (RBI) on climate risk management by the banks and other regulated entities (RE) are a timely and pathbreaking initiative. The guidelines titled Disclosure Framework on Climate-related Financial Risk, 2024, mandate that banks and other REs like insurance companies, mortgage lenders, brokerage firms, etc. make comprehensive disclosures on climate risk management practices. A survey conducted by the Sustainable Finance Group in the Department of Regulation, RBI, in 2022 found that in about a third of the banks in India, the responsibility for overseeing initiatives related to climate risk and sustainability issues was yet to be assigned. 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. The “Report of the Survey on Climate Risk and Sustainable Finance” published after the survey also brought to light that most of the banks have not aligned their climate-related financial disclosures with any internationally accepted framework. The report insisted that banks need to fully grasp the physical, transitional, and liability risks associated with climate risk and actively start managing them to make their loan and investment portfolios more resilient to such risks. It also underscored the need for banks to develop a strategy for managing climate risk and integrate it into their risk management framework. The rationale behind RBI pushing for a climate risk management framework for banks and REs has also been explained in it. “The economic and financial impact of climate change may give rise to possible losses for banks if the risks are not well managed,” it adds. Other key findings of the survey are: Four out of 12 public sector banks and seven out of 16 private sector banks were yet to consider climate-related financial risks as a material threat to their business; banks’ business models and exposures could increase the severity of climate-related impacts, and climate-related financial disclosures by banks would help identify the information needed by investors, lenders, and insurance underwriters to appropriately assess and price climate-related risks and opportunities. The RBI wrote to all banks and REs in February, cautioning them that, given the increasing threat of climate change and the associated physical damage, changes in market perception, and the transition towards more environment-friendly products and services, the impact of climate change on REs is inevitable. It insisted on a better, consistent, and comparable disclosure framework for REs, as inadequate information about climate-related financial risks can lead to mispricing of assets and misallocation of capital by them. The RBI guideline defines claimed-related “physical risk” of banks and Resto to be the economic costs and financial losses resulting from the increasing severity and frequency of: extreme climate change-related weather events such as floods, heatwaves, landslides, storms, and wildfires known as acute physical risks; longer-term gradual shift of the climate such as changes in precipitation, extreme weather variability, ocean acidification, and rising sea levels and average temperatures known as chronic physical risks; and indirect effects of climate change such as loss of ecosystem services (e.g., water shortage, degradation of soil quality, or marine ecology). For the disaster-prone Northeast region, these are of significant relevance. The challenges in implementing the RBI guideline include a lack of robust data to quantify the amount of their loan and investment portfolio that is susceptible to climate-related risks and banks and REs not having trained staff to handle such a specialised task. The survey highlighted that the majority of the foreign banks said that they had a team of over 20 staff for climate risk, sustainable finance, and environmental, social, and governance-related initiatives. In contrast, most public sector and some private sector banks were yet to allocate dedicated staff for the same.” Another key highlight of the report is that most of the surveyed banks have decided to gradually reduce their exposure to high-carbon emitting/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. Most banks have launched a few loan products to tap the opportunities from climate change, it adds. The push for renewables, electric mobility solutions, and electric vehicle charging stations to decarbonise the energy and transport sectors has created new opportunities for banks and financial institutions to finance such green initiatives. During the course of the survey, it was brought to the attention of the RBI that 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. Building the awareness and capacity of staff in the banks and REs will be crucial to fast-forwarding the implementation of the RBI guideline once the disclosure framework is finalized after stakeholder consultation.