Challenges and Opportunities in Scaling up Green Finance1
(Address by Shri M. Rajeshwar Rao, Deputy Governor, Reserve Bank of India -
December 22, 2022 - at the Business Standard BFSI Insight Summit)
1. A very good morning to all the distinguished dignitaries and participants at
this BFSI Insight Summit being organised by the Business Standard. I am
very happy to be amidst you today albeit virtually. In recent times, this
event has become a well-regarded platform for debate and deliberation on
contemporary issues in finance and has generated useful insights from the
wisdom of distinguished speakers who have graced the previous summits.
2. As we look back over the past decade and a half, what is really striking is
the fact that the financial sector has been buffeted by several financial
storms which it has bravely weathered. After each episode, the endeavour
had been to ensure that the institutions emerge stronger and more
resilient, so as to support the continuing narrative of recovery and growth.
The episodes of crisis of late have become more frequent with lesser
breathing space afforded to the institutions to recover, recoup and be
future ready. The evolving situation demands that both the regulators and
the regulated entities remain ever ready and well equipped to face the
emerging challenges, be it the growth of fintech, digitalisation of financial
services, customer service or the challenges of cybersecurity in the
financial services sector. But the key risk which I would like to discuss
today is the impact of climate change and what it can mean for the financial
services industry. In a way I am revisiting a topic on which I spoke about a
year back2 - climate risk and green finance. While this issue may still be
the new kid on the block as far as the deliberations in such financial
gatherings are concerned, it is fast becoming a key issue which is being
discussed globally and the urgency of the situation is more apparent to one
and all.
3. The recent Conference of Parties (COP-27) Summit in Egypt and the
United Nations Environment Programme's 'Emissions Gap Report 2022 -
The Closing Window' released in October 20223 have once again brought
to fore global attention on the measures required and the need for urgent
action. The hierarchy of actions and the agencies responsible for the same
is getting crystallised while there is a greater degree of agreement on the
manner in which to proceed further starting from taking effective steps for
reducing carbon emissions, to fostering sustainable patterns of production
and consumption and transitioning to a sustainable lifestyle in a cleaner
and greener earth. It is also clear that there is no room for differences on
the issue and only our collective efforts can address the challenge of
climate change.
4. Having said that, the question that emerges is what would be the role of
different institutions in achieving these objectives? While the overarching
policy approach would be guided by sovereign efforts and coordinated by
decision-making bodies such as the COP, the financial world needs to ask
the obvious question to itself - how can we help? As custodians of financial
stability, central banks and policymakers would also be required to
evaluate and examine the instruments or strategies they should leverage
or focus upon to meet sustainability goals without compromising on their
existing policy mandates. These are some of the dilemmas that I would like
to highlight today in my remarks.
5. Given its wide ranging economic and financial implications, climate-related
financial risks are already engaging the attention of international standard
setting bodies, central banks, and supervisors globally with the focus on
the need to promote the transition to a sustainable global economy. The
Reserve Bank too had come out with a Discussion Paper4 on Climate Risk
and Sustainable Finance earlier this year. Besides, RBI had also
undertaken a Survey on Climate Risk and Sustainable Finance among
leading scheduled commercial banks. There is a general consensus that
banks and financial institutions will play a key role in financing the transition
to a low-carbon economy and supporting the national climate
commitments.
6. While no entity is immune from climate risks, we in India are particularly
vulnerable to the climate change related physical risks5 and hence there is
a need to be more alive to the urgency of action6 given our long coastline,
high share of fossil fuels in energy systems, and relatively high
dependence of rural livelihoods on agriculture. Climate trends and events
have a direct bearing on the economy and resultantly have an impact on
the financial institutions and the financial system. According to a report7,
the transformation of the global economy needed to achieve net-zero
emissions by 2050 would be universal and significant, requiring $9.2 trillion
in annual average spending on physical assets, which is $3.5 trillion more
than what is being spent today. In the case of India, the Council on Energy,
Environment and Water8 has already estimated that a total investment of
US$ 10.1 trillion would be needed to meet our net zero commitments by
2070. This underscores the urgency of efforts for transitioning to a low
carbon economy. Ensuring access to adequate transtition finance and
supporting technology would be critical in this process.
7. Going forward, there are two key aspects which banks would need to focus
on - first, relying on their time-tested expertise in financial intermediation by
acting as an effective conduit for channelising finance to carbon efficient
sectors and industries in alignment with national policies and goals; and
second, improving the management of financial risks in their books which
may originate from climate change. Such risks range from the direct
physical risks emanating from adverse climate-related events to loss of
reputation and legal risks. Obviously, the strategies for mitigating these
risks would have to be encompassed by sound public policy objectives and
all stakeholders would need to play their role in helping the country
traverse and transform into a climate-resilient economy.
Challenges for Financial Intermediaries and Banks
8. Estimating the timing, frequency and severity of climate-related events is a
challenging proposition given the uncertainties involved in the process.
While significant progress has been achieved globally on developing
scenarios and forward-looking approaches for modelling climate risks, the
requirement of past data and the unpredictable nature of climate change
makes estimation of climate events and their financial impact a challenging
endeavour. Nonetheless, there is no alternative but to continue working on
this path of self-discovery and slowly gaining momentum as we cannot
afford to be inactive anymore.
9. The work at a global level which is being co-ordinated by the Financial
Stability Board (FSB) and endorsed by the G-20, rests on four building
blocks needed for addressing Climate-Related Financial Risks. These four
building blocks, viz., Disclosures, Data, Vulnerabilities Analysis and
Regulatory and Supervisory Practices and Tools which to my mind are pre-
requisites for a resilient financial system when augmented by informed
decision making. Let me discuss a bit further on these aspects.
10. An appropriate and adequate disclosure framework must have three key
attributes - first, it should have inter-temporal consistency, second, it
should be comparable and the third and most important is that it should be
useful for decision making. Climate-related disclosures by firms, that
largely contain these attributes, would help policymakers in understanding
the enormity of the task ahead in terms of the transition funding
requirements. Further, this would help banks understand the level of
carbon intensity in the business ventures in case they are to fund them so
that they are able to differentiate and appropriately price in such risks.
11. Internationally, a significant body of work has been done on disclosures.
The FSB's Task Force on Climate-related Financial Disclosures (TCFD)
and the International Sustainability Standards Board (ISSB) under the
IFRS Foundation have been leading this work along with other standard
setting bodies. In March 2022, the ISSB published Exposure Drafts on its
first two proposed standards. The first sets out general sustainability-
related disclosure requirements while the other specifies climate-related
disclosure requirements. Given the global nature of funding markets and
cross-border flows of capital, the idea is to agree upon a common global
baseline disclosure requirement which is interoperable among jurisdictions
for comparability and consistency. The Reserve Bank, as a part of
standard setting bodies has also been contributing and learning from global
discussions and experiences. In our recently published Discussion Paper
on Climate Risk and Sustainable Finance we have elaborated on how
climate-related disclosure is an important source of information for different
stakeholders (e.g., customers, depositors, investors, and regulators) of
REs to understand relevant risks faced by them and their approach to
addressing such issues.
12. For the corporates, beginning from the current financial year FY 2022-23,
SEBI has mandated Business Responsibility and Sustainability Reporting
(BRSR) for the top 1000 listed companies (by market capitalisation) in
India. The disclosures under the BRSR framework would incentivize green
financing and help banks and financial institutions in estimating their
climate-related exposure to these listed companies.
13. While consistent and comparable disclosures, the first building block,
would enable financial institutions make firm level risk assessments, the
second building block, data, is required for making macro level
assessment of risks. Like any financial risk, reliable and comprehensive
data on climate risk related exposures would aid in making sound policy
interventions and undertaking climate scenario analysis and stress testing
for the assessment of risks from climate events. This however is, easier
said than done. While global efforts are underway to create data
repositories and provide guidance on collection of data for better
comparability; availability of high quality, granular and sufficient data
remains a challenge as of now. Availability of granular data also remains
crucial for modelling the forward-looking nature of climate events and
developing metrics for monitoring climate-related financial risks.
14. The third building block, vulnerabilities analysis, is again a macro level
exercise to understand the financial stability risks arising out of climate
events and their impact on financial systems. It is focused on analysis and
stress testing using various scenarios to help in better assessment of
potential pressure points in the financial system and in understanding
interlinkages between financial sector and real sector. While the
development of climate scenario analysis, stress testing scenarios and
analytical tools are still in their infancy, the need for integrating them with
regular monitoring exercises and overall financial risk assessment has
been well recognised. One particular challenge in modelling climate-related
risks is the long time horizon which has to be considered. The climate
events may often span across decades, if not centuries, and this may
make the data collection exercise quite difficult and the outcomes more
uncertain.
15. The fourth and final building block consists of initiatives which are being
undertaken or planned by the regulators and supervisors to facilitate
transition. In a way, this is a culmination of the work taken up under the
three building blocks discussed above. The regulators may need to fine
tune the existing prudential policies to integrate the climate risks into the
regulatory frameworks. At the same time, from a supervisory perspective,
the expectations may have to be set and communicated to all regulated
entities regarding climate-related risks, encompassing organisational
strategy, governance, risk management and assurance functions. The
global efforts undertaken so far seem to suggest that integrating climate-
related risks and capturing them by fine tuning existing prudential
frameworks may be possible.
16. The Basel Committee on Banking Supervision (BCBS) has published
Principles for the Effective Management and Supervision of Climate-related
Financial Risks in June 2022. In October 2022, the Financial Stability
Board (FSB) published its Final Report on Supervisory and Regulatory
Approaches to Climate-related Risks. Earlier in March 2022, the NGFS
published a 'Statement on Nature-related Financial Risks', which
acknowledges that failure to account for, mitigate, and adapt to nature-
related risks could have significant macroeconomic implications and
become a source of financial stability risk. While guidance has been made
available, regulated entities may need time, resources, and capacity to
integrate climate-related considerations into their decision-making
frameworks and customer facing business lines.
Private Sector Initiatives
17. In the private sector, decarbonization and digitalization are emerging as
megatrends that could compel sectors and corporates to undertake
structural changes and fundamentally alter their traditional business
models. It is heartening to note that some of the leading Indian companies
in the hard to abate sectors like steel and cement9, for example, are
working on an ambitious decarbonization agenda aimed at reducing the
carbon footprint in their production process.
18. Banks and financial institutions may have to to step up their engagement
with their corporate customers on ensuring sustainability-focused financing
and other support services to help them transition towards a low-carbon
economy while reducing their own carbon footprint. The financial sector
can channel resources towards green projects / businesses by offering
suitable and customised products to businesses.
19. Over the past three years, the Sustainability-Linked Bonds and
Sustainability Linked Loans (SLBs and SLLs) market has been a fast-
growing segment globally in the sustainable finance market10. India too,
has seen the introduction of sustainable finance instruments such as
sustainability-linked loans. Liberalised External Commercial Borrowings
(ECB) norms have also enabled Indian companies to raise offshore finance
through green bonds, social bonds, sustainable bonds, and sustainability-
linked bonds. In line with global trends, the issuance of sustainable debt
has risen sharply in India during Calendar Year 2021 taking it to the 2nd
place among emerging economies in cumulative Green Bond Issuances11.
Mechanisms such as blended finance12 and risk-sharing facilities are also
being utilised to finance climate and sustainability-related projects.
20. The above initiatives from the financial sector in India and across the globe
make one believe that the private sector is very much alive to the
challenges ahead of us.
Public Sector Initiatives in India
21. To move the needle towards net zero, we must progressively decarbonise
all sectors of the economy, including the hard-to-abate ones. This means
that we would need to incentivise banks to provide support in terms of
transition finance for businesses and sectors that are not so green, to
adopt cleaner technologies, increase energy efficiency and become
greener over time. Green finance can play a crucial role in making India's
economy resilient to climate change impacts. During the COP26 Summit in
November 2021, the Hon'ble Prime Minister had announced that by the
year 2070, India will achieve the target of net-zero. This would necessitate
creating an enabling ecosystem for financing India's transition to a green
economy.
22. In India, both the Government and Reserve Bank of India have been
participating in the global discussions on climate risks and have already
taken quite a few initiatives in this regard. The Government, in the Union
Budget for 2022-23 announced that climate action would be a key priority
and proposed that as a part of its overall market borrowings in 2022-23,
Sovereign Green Bonds (SGBs) will be issued for mobilizing resources for
green infrastructure. The proceeds will be deployed in public sector
projects which will help in reducing the carbon intensity of the economy.
This is by no means a small step. Over time, the SGBs would provide a
pricing reference for the private sector entities in India for their INR
denominated borrowing for ESG linked debt. Thus, the issuance of SGBs
would help in creating an ecosystem which fosters a greater flow of capital
into green projects and entities undertaking such projects.
23. Recognising the need for concerted efforts in the area, the Reserve Bank
has concomitantly set up a Sustainable Finance Group (SFG) within its
Department of Regulation in May 2021 to lead the regulatory initiatives in
area of climate risk and sustainable finance in the Indian context. As I
mentioned previously, RBI had already released a Discussion Paper on
Climate Risk and Sustainable Finance in July 2022 covering a gamut of
issues on the RBI's website for comments of stakeholders. It is heartening
to mention that we have received comments from a large number of
regulated entities and other stakeholders. These are being carefully
examined before we frame any regulatory guidance on climate risk and
sustainable finance.
24. Along with the Discussion Paper, we had also released the results of a
survey undertaken to assess the approach, level of preparedness and
progress made by leading scheduled commercial banks in India for
managing climate-related financial risk. The survey, which covered 12
public sector banks, 16 private sector banks and 6 foreign banks, provided
useful insights and the feedback from this exercise will help in shaping our
regulatory and supervisory approach.
25. Another notable feature for our financial ecosystem is that while rest of the
world is still grappling in developing new instruments to funnel funding to
green and sustainable companies and projects, we already have a well-
accepted incentive-based instrument in the form of Priority Sector Lending
(PSL) norms to encourage lending to such projects. Over the years, we
have been taking various policy measures to promote and support green
finance initiatives through this route. For example, renewable energy
projects have been included as a part of Priority Sector Lending (PSL). In
2012, Reserve Bank included loans sanctioned by banks directly to
individuals for setting up off-grid solar and other off-grid renewable energy
solutions for households and in 2015, the PSL criteria was expanded to
bank loans up to a limit of ₹15 crore to borrowers for purposes like solar /
bio-mass based power generators, windmills, micro-hydel plants and for
non-conventional energy based public utilities, viz., street lighting systems,
and remote village electrification. In 2020, this limit for bank loans was
doubled to ₹30 crore. It is heartening to note that in recent years, leading
banks in India have also begun stepping up their exposure to the
renewable energy sector.
Enablers for Scaling up Green Finance in India
26. Banks and financial institutions have always been the backbone of India's
economic growth and as the country pivots to sustainable growth, they will
have to take a lead and accelerate green lending. To support this
acceleration, a number of structural changes may be needed in the
traditional lending approach, including evaluation and certification of the
green credentials of projects. In order to give focused attention to scaling
up green finance, banks and financial institutions would have to invest in
human resources and capacity building efforts as well as integrate
environmental and social risk considerations into their corporate credit
appraisal mechanisms.
is the need of
27. A formal definition of green finance along with a taxonomy13
hour as it would enable more precise tracking of finance flows to green
sectors in India, which in turn, would help design effective policy,
regulations and institutional mechanisms directed towards increasing both
public and private investments. A taxonomy would also help banks and
financial institutions in better assessing the climate risk in their loan
portfolio, scaling up green and sustainable finance and mitigating the risk
of greenwashing.
28. Another key challenge in scaling up green finance is the availability of a
robust ecosystem for third party verification / assurance and impact
assessment and the green credentials of businesses and projects. This
would also address potential greenwashing concerns and ensure
unhindered flow of capital and funding to the entities.
29. The challenge regarding the availability of data and disclosures would also
need to be addressed quickly. In this context, the disclosure standards
prescribed by SEBI for top 1000 listed entities by market capitalisation is a
welcome step. I am confident that the listed entities would not only adhere
to the mandatory disclosures but would also not hesitate to follow those
which are additional and voluntary in nature.
30. Green finance must be scaled up rapidly to meet India's climate targets
under the updated Nationally Determined Contribution communicated to
the United Nations Framework Convention on Climate Change (UNFCCC)
in August 2022. The enhanced ambition requires mobilization of green
finance at a much faster pace. For example, green infrastructure
investment trusts could help scale up green finance as also deepen the
local bond market. But in the end, all these ideas need a clear intent from
all stakeholders in order for it to be implemented and sustained.
Concluding Remarks
31. To sum up, climate change may result in physical and transition risks that
could have implications for the physical safety and financial soundness of
individual regulated entities as well as for the stability of financial system.
Thus, there is a need for regulated entities to develop and implement
comprehensive frameworks for understanding and assessing the potential
impact of climate-related financial risks in their business strategy and
operations.
32. We need to be conscious that climate risk is the biggest challenge
confronting us and addressing it decisively is our joint responsibility.
Financial sector has a key role to play as it is the sector which finances
businesses and can influence their activities. Banks would have their role
cut out in handholding the businesses and arranging for the transition
finance required by the firms as they try to shift their strategies to make
them more sustainable and planet friendly. The central banks can play a
significant role in shaping the response of financial sector to the
challenges posed by risks emerging from the climate change through
appropriate guidance and regulations.
33. The Indian economy is at a stage where we need to grow rapidly but the
challenge before us is to think of ways to incorporate climate risk and
ESG-related considerations into commercial lending and investment
decisions while simultaneously balancing the needs of credit expansion,
economic growth, and social development. Collective engagement would
help build on our early progress and go a long way in addressing the
challenges of climate change.
Let me conclude now and leave you with these points to ponder as you
continue with your deliberations during the course of the ensuing discussions
at this event.
Thank you for inviting me to share my thoughts at this summit and thanks for a
patient hearing.
*****