RBI'S GREEN GAMBIT
The central bank's initiative on battling climate risks, signals a new corporate governance regime is in the offing. EPISODE #88
Dear Reader,
A very Happy Monday to you.
Late last month the Reserve Bank of India (RBI), the country’s central bank, published a discussion paper that would have set the cat among the pigeons. It calls upon India Inc to come up with a new corporate governance strategy to combat climate risks.
One, it very bluntly posited that climate change is for real and that it will need mitigation. Second, it believes that the associated physical and transition risks could impact businesses, posing risks to the financial stability of India.
Further it signalled that change will begin with banks reordering their lending norms to factor for these risks, implicitly putting India Inc on notice. So this week I explore RBI’s move and the attendant implications.
This week’s cover picture is sourced from Unsplash and taken by Nandhu Kumar. Thank you Nandhu.
A big shoutout to Yugainder, Lakshmisha, Kartik, Premasundaran, Gautam, Vandana, Atul, Aashish and StratNews Global for your informed responses, kind appreciation and amplification of last week’s column. Gratitude also to all those who responded on Twitter and Linkedin. Reader participation and amplification is key to growing this newsletter community. And, many thanks to readers who hit the like button😊.
CLIMATE RISKS
The 17th edition of the Global Risks Report released by the World Economic Forum (WEF) identified environmental risks among the two biggest threats facing the world for the next five years.
The outlook of the survey only worsens over a longer period with respondents identifying environment as the “five most critical long-term threats to the world as well as the most potentially damaging to people and planet”.
These warnings are not new. Neither are the dire forecasts. What is new is the growing tractions of institutions to not just take notice but initiate conversations, if not action, to mitigate these climate risks.
In India this conversation has already taken political centre stage with Prime Minister Narendra Modi committing India to:
Reach net zero emissions by 2070;
Achieving a target of 50% renewable energy by 2030.
At the institutional level, the Ministry of Finance constituted an expert group to define a green taxonomy—which will set transparent standards for projects to be identified as green and hence becoming eligible for green-finance.
Even while the report of this expert group is awaited, the country’s central bank, the Reserve Bank of India (RBI), has signalled that policy action is imminent.
The RBI first declared its intent in its statement on development and regulatory policies released in April. Very unequivocally RBI stated its concerns:
“Climate change may result in physical and transition risks that could have implications for the safety and soundness of individual Regulated Entities (REs) as well as financial stability.
Thus, there is a need for REs to develop and implement a sound process for understanding and assessing the potential impact of climate-related financial risks in their business strategy and operations.”
And then added:
“A discussion paper on climate risk and sustainable finance covering the above aspects will be placed shortly on the RBI’s website for comments of stakeholders.”
True to its word, RBI released the discussion paper late last month. With this it has set the clock in motion where the nudge for change will come from banks and financial institutions—not only will this entail a reordering of their own house but also their lending practices, both of which have implications for India Inc’s future funding.
Clearly, the question now is not whether India will undertake institution inspired climate change mitigation. Instead it is about when this will be effected.
RBI Speak
According to two departments of the government of India there are more than sufficient warnings about climate change. First the latest annual report of the Indian Meteorological Department (IMD) disclosed grim findings:
2021 was the warmest year since 1901; 11 of the 15 warmest years occurred between 2007 and 2021.
Natural disasters (including instances of extreme weather) are spiking: Of the 756 recorded instances, 402 occurred between 1900-2000 and 354 in the last two decades ended 2021.
Separately the Ministry of Earth Science concluded that India is witnessing:
Rise in average temperature;
Decrease in monsoon precipitation;
Increased frequency and intensity of cyclones;
Rise in extreme temperatures, droughts and sea levels.
Connecting the dots the RBI in its preface to the discussion paper argued that this inclement fallout of climate change was posing a financial risk to banks. The logic is simple. These kind of unexpected events are likely to cause loss of output, damage to investments and so on, which could potentially impact profitability and thereby the ability of these companies to service the debts owed to banks.
Accordingly it issued the following guidance:
“The uncertainty about the timing and severity of climate-related and environmental risk certainly threatens the safety, soundness and resilience of individual Regulated Entities (REs) and, in turn, the stability of the overall financial system.
It is therefore recognized that the REs should steadily manage the risks and opportunities that may arise from climate change and environmental degradation.”
The thing is that it is not just RBI, but every other central bank which is now alert to the fact that climate change is poised to exact serious costs. The Financial Stability Board (FSB), the apex global body which monitors the global financial system, is acting as their guide.
So far it has recommended a four fold strategy that will focus on:
Disclosures;
Data;
Vulnerability analysis;
Regulatory/supervisory guidance.
And like in the case of money laundering, wherein domestic laws are taking their cue from the advisories issued by the United Nations body, the Financial Action Task Force, the climate change response from RBI too will be guided by the FSB.
Battle Ready?
The big question then is whether India’s financial sector is aware of the challenge? More importantly, are Indian banks equipped to retool itself for the vastly altered circumstance?
To assess their preparedness, the RBI carried out a survey of 34 commercial banks—including 12 public sector banks, 16 private sector banks and six foreign banks—in January this year.
The findings were a wake-up call:
In a third of the banks, responsibility for overseeing initiatives related to climate risk and sustainability was yet to be assigned.;
Only a few included climate risk/sustainability/environmental, social and governance (ESG) related Key Performance Indicators (KPIs) in the evaluation of the top management;
Majority of the banks did not have a separate business unit or vertical for sustainability and ESG-related initiatives;
And this despite the fact that majority of the banks considered climate-related financial risks to be a material threat to their business.
The good news though was that almost all the banks considered physical and transition risks to be the main climate related challenges. And a few of them bucked the larger trend and had begun to screen their loan and investment portfolio to ascertain climate risks.
Further, several of them signalled their intent to wind down their exposures to high-carbon emitting businesses and have in fact launched a few loan products to tap the opportunities for green finance.
Risk=Opportunity
As they say there is a silver lining in every cloud. The mitigation strategy to combat climate change is also a business opportunity.
A study conducted by the International Finance Corporation, an affiliate of the World Bank, in 2017 values this green investment potential at $3.1 trillion—the size of India’s current gross domestic product—by 2030.
To realise this investment India will need to tap private sources from abroad; ideally, the developed world should bear bulk of this cost, given their historical contribution to damaging the world’s environment, but the unfortunate reality is that this will not happen. (Yes the double speak of the developed world on environment and their recent actions of vaccine capture is galling.)
To tap this global market for green finance India will need to do two things:
One it has to align all its stakeholders, particularly India Inc, to the climate mitigation strategy. In other words, not just RBI, but every other regulatory body will have to get into the act.
Second, India needs to quickly define the green metrics (or taxonomy) such that projects are transparently identified as potential green investments—this is to avoid green-washing wherein polluting projects are masked and included under the green umbrella. China and South Africa are off the blocks, having gone public with their taxonomy.
As mentioned, right at the beginning, a group within the finance ministry has been assigned to set out this green-taxonomy; I believe the report is ready but yet to be made public.
It is then clear that forewarned is forearmed as they say. RBI’s discussion paper does precisely that. Presumably India Inc is cognisant about the impending reset to corporate governance norms to enable a climate mitigation strategy. If not, it is time to wake up and smell the coffee.
Recommended Viewing
After a week’s gap the other avatar of Capital Calculus was back on air on StratNews Global.
As mentioned in my last newsletter, the reason for the hiatus was a cyber attack which disabled their site. All is good now with StratNews sanitising the systems and reinforcing their cyber security.
The latest episode takes up from the the theme of the newsletter published on 15 August.
This time I am in conversation with Pramod Varma, the former chief architect of Aadhaar and presently the CTO of Ek Step. At the risk of sounding like a plug I would recommend it to all.
Pramod very compellingly unpacked the unique prowess of India’s digital economy in undertaking public good at scale. In short the episode is unmissable.
Till we meet again next week. Stay safe.
An article of critical importance, as it will be a wakeup call for all readers and very skillfully written and presented. We have been made increasingly aware of the perils of climate change due to the rampant exploitation of vulnerable areas and resources; and a callous attitude towards commercial gains but this write up has methodically highlighted key points of the disaster ahead and more importantly the positive steps being taken by financial institutions and their governance by apex bodies to make a significant impact on steering the world towards environmental protection and transformation into a more climate friendly approach. Even the areas of immediate focus have been mentioned with figures. An eye opener that has left far more aware on the subject. Thank you Anil and keep enlightening us.
Dear Anil,
You are absolutely correct as climate and geopolitics have hit agricultural output, food self sufficency and economic growth of countries.
A premature and abnormally long heatwave this year seriously damaged India's wheat crop. Large parts of India's rice growing region are staring at shortfall in rice output, again due to climate change.
The food security situation would have been far worse if India did not have strategic food reserves and buffer stocks.
While the farmers face the worst effects of climate crisis, a large section of them are contributing to harming the environment, even if it is done inadvertently. The farmers have to be informed and educated about the importance of environmental sustainability.