Syllabus
GS Paper 3 – Indian Economy and issues relating to planning, mobilization, of resources, growth,development and employment.
Applications where to apply?
When asked about
– Net zero transition and financial sector
– Green Jobs
– Climate change
– Sustainable Development
Context
The article discusses RBI’s draft disclosure framework on climate-related financial risks and its implications for green transition.
Source
The Indian Express | Editorial dated 8th March 2024
RBI and the net-zero transition — A roadmap for green India
The transition towards a net-zero economy entails significant changes across sectors, particularly impacting the financial system. In India, where fossil fuel consumption remains considerable, the banking sector faces crucial challenges in adapting to this transition. The Reserve Bank of India (RBI) has recognized the importance of aligning policies with climate goals and has introduced a draft framework aimed at assessing and managing climate-related financial risks.
What is Net – Zero?
Net zero refers to achieving a balance between the amount of greenhouse gases going into the atmosphere and the amount being removed.
This can be achieved through two main approaches:
- Reducing Emissions: This involves transitioning to cleaner energy sources (like renewables), improving energy efficiency, and reducing emissions from industrial processes and agriculture.
- Removing Emissions: This involves capturing and storing carbon dioxide that has already been emitted. Techniques for this include planting trees (which absorb CO2) and using technology to capture emissions from power plants
Net-Zero transition risks
Several risks are associated with the net-zero transition in India’s banking sector:
- Climate Change Risk Exposure: Banks and non-banking financial companies (NBFCs) have significant exposure to sectors such as utilities, metal, transport, power, and auto segments, which are vulnerable to climate change risks. The exposure to these sectors may pose risks to the financial system as fossil fuel-based assets are phased down.
- Loan defaults: As fossil fuel-based sectors decline, loans to these companies may become risky if they struggle to adapt or go bankrupt.
- Interconnectedness Risk: There is interconnectedness between banks and NBFCs, and nearly half of NBFCs’ gross credit is extended to power and auto segments.
- This interconnectedness could amplify the risks to the financial system if there are disruptions in these sectors due to the transition to net zero.
- Mispricing of Assets and Misallocation of Capital: Without adequate disclosure frameworks and risk assessment tools, there is a risk of mispricing assets and misallocating capital.
- Lack of information about climate-related financial risks may lead to inefficient allocation of resources.
- Systemic Risks: Systemic risks are more pronounced in sectors with long-term lending and those prone to extreme weather events. Transition risks associated with climate change could affect the stability of the financial system if not managed effectively.
- Technical Capacity and Capacity Building: There is a variation in the technical capacities of banks to assess and manage climate-related risks.
- Asset Quality Risks: While transitioning to net zero, banks need to monitor not only the asset quality in fossil fuel-based sectors but also in “green” sectors.
- Credit Risk in Green Sectors: New green technologies and industries may have higher initial risks, potentially leading to loan defaults.
- Underestimating Long-Term Risks: Short-term loan cycles may mask long-term climate risks, making banks vulnerable to extreme weather events impacting borrowers.
Mitigating these risks
- Risk Assessment and Scenario Analysis: Banks and financial institutions should conduct thorough risk assessments and scenario analyses to understand the potential impacts of transitioning to net zero on their portfolios.
- This involves evaluating different scenarios, including
- Regulatory changes
- Technological advancements, and
- Shifts in consumer behavior, to anticipate potential risks and opportunities.
- This involves evaluating different scenarios, including
- Diversification of Portfolios: Banks should consider diversifying their portfolios away from fossil fuel-dependent sectors and towards green investments.
- This can help mitigate risks associated with stranded assets and declining valuations in traditional industries while capitalizing on opportunities in renewable energy and other sustainable sectors.
- Integration of Environmental, Social, and Governance (ESG) Criteria: Incorporating ESG criteria into investment decisions can help banks identify and mitigate climate-related risks while also promoting sustainable development.
- By considering factors such as carbon footprint, environmental impact, and social responsibility, banks can align their investment strategies with long-term sustainability goals.
- Capacity Building and Training: Enhancing the technical capacities of banks and financial institutions is essential for effectively implementing climate-related risk management strategies.
- Collaboration and Knowledge Sharing: Collaboration among banks, regulators, government agencies, and other stakeholders is crucial for sharing best practices, exchanging information, and collectively addressing climate-related risks.
- Transparency and Disclosure: Improving transparency and disclosure of climate-related risks and opportunities is essential for enabling informed decision-making by investors, regulators, and other stakeholders.
- Banks should enhance their reporting practices to provide accurate and comprehensive information on their exposure to climate risks.
| Draft Disclosure framework on Climate-related Financial Risks, 2024 The regulated entities(REs) should disclose information about their climate-related financial risks and opportunities for the users of financial statements. It will foster an early assessment of climate-related financial risks and opportunities and also facilitate market discipline. Applicability The framework shall apply to: All Scheduled Commercial Banks (excluding Local Area Banks, Payments Banks and Regional Rural Banks) All Tier-IV Primary (Urban) Co-operative Banks (UCBs) All All-India Financial Institutions (viz. EXIM Bank, NABARD, NaBFID, NHB and SIDBI) All Top and Upper Layer Non-Banking Financial Companies (NBFCs) Thematic Pillars for Reporting: Governance: Entities must detail internal processes and oversight related to climate change. Strategy: Specifying impacts and issues over short, medium, and long terms is required. Risk Management: Assessment of stress through climate-scenario analysis aligning with national policies. |
Other measures taken by the RBI for Green transformation
- Green Deposits
- Sovereign Green Bond
- Lending to renewable energy under priority sector lending: This incentivizes banks to lend to renewable energy projects, promoting clean energy adoption.
- The Reserve Bank of India (RBI) joined the Central Banks and Supervisors Network for Greening the Financial System (NGFS) as a Member to foster international collaboration.
Conclusion
The RBI’s draft framework marks a crucial step towards integrating climate risk considerations into India’s financial landscape. By emphasizing transparency, strategy, and risk management, the framework aims to mitigate systemic vulnerabilities and promote sustainable finance. As the financial sector prepares to navigate the transition to a net-zero economy, collaboration between regulators, financial institutions, and policymakers will be essential to ensure resilience and alignment with India’s climate goals.
Related Topics
Panchamrit Goals
India made five major announcements at the COP26 climate change meeting in Glasgow, which is dubbed as ‘Panchamrit goals’:
- First– India will increase its non-fossil energy capacity to 500GW by 2030.
- Second– India will meet 50% of its energy requirements from renewable energy by 2030.
- Third– India will reduce the total projected carbon emissions by one billion tonnes from now onwards till 2030.
- Fourth– By 2030, India will reduce the carbon intensity of its economy by 45%.
- Fifth– By the year 2070, India will achieve the target of Net Zero.
References
Practice Question
Evaluate RBI’s role in India’s net zero transition. How can it enhance risk management and promote green investments? [150 words]
How to approach this question?
Introduction (20 words):
- Briefly introduce the Reserve Bank of India (RBI) and its potential role in India’s transition to net zero emissions.
Body (100 words):
- Discuss the current role of RBI in managing financial risks related to climate change and promoting green investments.
- Evaluate how effective these measures have been in supporting India’s net zero transition.
- Suggest ways in which RBI can enhance its risk management strategies to better address climate-related financial risks.
- Discuss how RBI can further promote green investments, for example, through regulatory measures, financial incentives, or collaboration with other stakeholders.
Conclusion (30 words):
- Summarize the key points discussed in the body of the essay.
- Highlight the importance of RBI’s role in India’s net zero transition and the potential impact of the suggested measures.
Remember to provide a balanced answer, incorporating relevant facts and figures, and propose feasible solutions. Structure your answer well, with a clear introduction, body, and conclusion. Also, ensure that your answer is within the word limit specified for the exam. Good luck!