Greening financial entities

The Reserve Bank of India’s draft guidelines for disclosure on climate risks and opportunities were released on March 28 for public feedback. The norms are a balanced response towards keeping the Indian financial system resilient in the face of climate shocks and helping regulated entities (REs) systematically steer financial resources to opportunities presented by green transition.

The guidelines use the existing Pillar 3 disclosure requirements of the Basel Committee on Banking Supervision to provide a more structured and forward looking information on climate risks and opportunities. Comparable and credible public disclosures can help REs’ investors, customers, depositors and regulators assess the resilience of REs’ business models in response to climate change. To achieve this, the draft guidelines align themselves with the International Sustainability Standards Board recommendations and national guidelines such as SEBI’s BRSR where these capture the relevant climate information.

While the guidelines provide a time bound practicable roadmap for the REs, making them work will require some immediate challenges to be addressed. Their successful implementation will also need steps to be taken in parallel by other authorities.

Differentiated glide path: The guidelines follow a four year implementation glide path starting next financial year (FY26) catering to different kinds of REs. All REs except urban cooperative banks (UCBs) will start reporting next financial year (UCBs will follow in FY27) on governance, strategy, risk management. Given that the level of disclosures would vary according to the size, scale and complexity of the operations of the REs, RBI further differentiates between baseline and enhanced disclosures, with the latter being optional for some entities. The guidelines make reporting on metrics and targets mandatory after the first year. By FY29, all REs will be reporting on all four parameters. The guidelines will apply to scheduled commercial banks, top layer NBFCs, UCBs and All India Financial Institutions.

Climate focussed requirements and challenges: Three requirements contained in the guidelines and attendant challenges merit special mention. First, RBI requires that REs identify and quantify risk over the relevant time horizon — short, medium or long term — and link it with their planning timelines for effective strategic decision-making. Time horizons for physical climate risks such as floods, droughts and changes in rainfall pattern can vary from very short (like a year) to very long (spanning decades) making risk modelling and exposure assessment a tricky business for REs without robust granular data.

Similarly, transition risks due to changes in policy, technology and consumer choices can manifest differently in different climate scenarios across different time horizons. While the guidelines suggest that REs use the available and applicable global or national guidance on plausible climate scenarios, and define time horizons as applicable to them, this is a huge undertaking. It will also make comparability in disclosures challenging.

Second, RBI requires REs to report on reducing their financed emissions — the GHG emissions attributed to the loans and investments made by an RE to its investee or counterparty. Capturing financed emissions of banks when an intermediary is involved such as an NBFC that borrows from banks and on-lends to high carbon emitting entities will also be equally important given the interconnectedness between banks and NBFCs in the Indian financial ecosystem. How will this be captured is not entirely clear in the reporting requirements on financed emissions for banks.

Third, RBI requires REs to disclose transition plans if they have one. This could be a highly enabling aspect of the guidelines as it allows a multi-year approach beyond the usual financing or investment time horizons to facilitate a more comprehensive assessment of climate risks, and is a way to build accountable bank-borrower engagement to expedite shifts in capital allocation. Transition planning and plans also allow for a more integrated approach on mitigation and adaptation. More details from RBI or adoption of available third party guidance and good practice will help guide the REs.

Need for enhanced capacities: Accurately capturing climate impact on REs’ balance sheets will remain a challenge. REs will need to upgrade climate stress testing capacities; and technical and methodological skills will need to be ramped up rapidly within REs as well as within the RBI’s relevant departments.

Appropriate steps and further coordination are needed on three fronts for successful implementation of these guidelines. First, a sustainable finance taxonomy that includes definitions of transitional activities will help assess the greenness of RE portfolios. This awaits action by the Finance Ministry which had anchored the taxonomy process in 2021-22.

Second, forward looking disclosure requirements on climate, including on transition plans, for businesses will be needed for granular data to flow from the borrowers to REs. This is in the purview of SEBI. Third, transition trajectories aligned with 2070 for different sectors are not yet in place. This requires further work by organisations such as NITI Aayog and coordination among relevant ministries.

The writer is Head, South Asia, Climate Bonds Initiative

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