Rajeshwar Rao: Climate implications for central banking
Remarks by Mr Rajeshwar Rao, Deputy Governor of the Reserve Bank of India, at a
panel discussion on "Climate Implications for Central Banking", organised by the IMF
and Center for Social and Economic Forum, New Delhi, 19 July 2023.
* * *
Good Afternoon, Ladies and Gentlemen,
Thank you for inviting me to participate in this dialogue and the Panel Discussion on
'Climate Implications for Central Banking'. Climate change and its impact on us is no
longer a distant threat. Rising global temperatures, extreme weather events, changing
weather patterns and the degradation of ecosystems are threatening our lives and
livelihoods. We therefore have to face up to the challenge of climate change sooner, not
later. Now, it is up to us to deal with this in a calibrated and well-planned manner or
deal with it once we are pushed into a corner with little elbow room. Therefore, the
timing of this dialogue is quite appropriate and provides an opportunity to discuss and
deliberate on this issue.
Climate change poses a threat to our long-term growth and prosperity. It has potential
to create shocks to monetary stability, growth, financial stability, the safety and
soundness of regulated entities. Therefore, keeping in view the theme of today's
discussion, in my remarks I intend to focus on the role of central banks in managing the
outcomes from climate change.
A range of factors would influence how things pan out in future, including changes in
climate-related policies and regulations, emergence of newer technologies, and
behavioural changes in consumers. To ensure a successful transition to a sustainable
future, we need a multi-faceted approach that involves governments, private sector
entities, financial institutions, civil society organizations and the public.
Central banks, typically, are concerned with the questions of monetary policy and
growth, of financial stability and regulation and supervision of financial system. In many
countries, including India, the Central Banks are statutorily mandated to pursue a given
set of objectives. This means that they should address risks and threats that impact
their core mission. Climate change does pose such a risk. They must, therefore,
manage outcomes which could affect the stability of the financial system and safety and
soundness of the financial entities.
From a banker's perspective Climate risks can impact the macroeconomic outcomes
primarily from two channels - i.e., physical risks and transition risks. While physical risks
refer to direct outcomes of climatic events, such as wildfires, storms, and floods, the
transition risks refer to the risks arising from the process of adjustment towards
reducing the emission intensity of the economy. For example, extreme weather events
such as storms or floods can disrupt production and supply chains and create
shortages of essential goods and services. This could lead to a sudden increase in
prices leading to inflationary pressures. Again, in India, rising temperatures, heat waves
and changing rainfall patterns can also affect crop yields resulting in higher or, at times
lower prices of some of the agriculture produce. This may lead to uncertainty in their
prices for both - producers and consumers. Such uncertainties can make measurement
and management of inflation and anchoring of inflation expectations difficult.
Another challenge that may arise on account of physical risk dimension of climate
change is increased probability of loss to banks and financial institutions. First, the
operations of these financial institutions, if concentrated in a vulnerable geographical
location, may be vulnerable to losses on account of climate events. Second, the assets
which they have financed or taken as collateral may become unavailable or lose value
due to adverse climate events. Such loans may turn non-performing, impacting bank's
capacity to lend further.
The transition risks, if not managed properly, could also lead to sudden fall in asset
prices of the carbon-intensive assets or increase in the risk premia, or both, making
them unattractive to hold and perhaps creating larger ripples across the financial
markets. On the other side, the prices of green assets may rise disproportionately
creating a bubble-like situation. Further, increased demand of such assets may give
rise to greenwashing concerns. Disorderly transition could create piquant situations
where a sector or industry may witness credit withdrawal or restrictive cost without
buildup of sufficient and viable alternatives. Such situations may become a limiting factor for
production of essential commodities or increase the cost of production.
Central banks are, therefore, beginning to recognise and evaluate risks which climate
change may pose to monetary policy, financial stability and regulated entities. More
Importantly, the risks arising from climate change transverse geographical boundaries
and sectoral segmentations. Therefore, tackling climate change requires global
coordination and co-operation. Being mindful of these challenges, international
organisations such as the IMF and standard-setting bodies such as the BCBS and FSB
are stepping up their work on issues relating to climate change.
At the global level, several initiatives are already underway under the aegis of the G-20.
Different standard setting bodies are undertaking focused work to address the
vulnerabilities arising from climate change. The Financial Stability Board (FSB) had
published a "Roadmap for Addressing Financial Risks from Climate Change", which
was endorsed by the G20 in July 2021 and has since been updated. The Roadmap sets
out a comprehensive and coordinated plan for addressing climate-related financial risks
and covers four areas, i.e., firm-level disclosures, data, vulnerabilities, and regulatory
and supervisory practices & tools.
The consequences, intensity, severity, and frequency of climate events are hard to
measure and difficult to predict. The impact of these events on banks and financial
institutions is even more difficult to quantify. Therefore, the first step in managing the
risks to which banks and other regulated entities are exposed from climate events, is to
measure the amount of exposure at risk. This is only possible if the firms adequately
and transparently disclose the carbon intensity of their operations. The data related to
exposure of firms, banks and financial institution to climate events is crucial for planning
the transition. International Sustainability Standards Board (ISSB) has been working on
designing global sustainability-related disclosures. The standards will help improve trust
and confidence in sustainability disclosures in companies and also create a common
language for disclosure about the effect arising from climate-related risks and
opportunities on their prospects.
The next step in this process is ensuring availability of data and identification of
vulnerabilities. For this we need time consistent, transparent, standardised, and
forwardlooking disclosures for identification of vulnerabilities. At a firm-level, the scenario
analysis and stress testing would help frame the strategies to manage the risks for
individual entities. Central banks across the globe are encouraging banks and other
lenders to identify such vulnerabilities. In India, we plan on issuing guidance to banks
on the stress testing for climate vulnerability of their credit portfolio soon.
Further, by the virtue of their mandate for regulating and supervising the financial
sector, central banks are uniquely placed to influence the behaviour of institutions within
the financial system, incentivize climate-friendly investments, and support the
mobilization of capital for sustainable development. Most often, central banks have
used positive reinforcement and incentive structure to encourage green finance.
Financial markets are also increasingly beginning to integrate climate risks and
opportunities into investment decision making. The number of ESG-focused funds is
increasing globally. Institutional investors are expecting their investee companies to
make detailed climate-related financial disclosures, pursue net-zero goals, declare
transition plans and report progress. Green bonds, climate funds, and blended finance
mechanisms can attract private investment towards climate projects. However, these
developments do also give rise to greenwashing concerns which may require regulatory
interventions in future to ensure that what is being projected as 'green' is, in fact,
actually 'green'.
At the cost of repetition, let me emphasize that financing the new green ventures alone
will not be enough. We would need credible transition plans for existing emitting firms
without compromising their output or growth. For this to materialise, central banks can
incorporate climate-related risks into their supervisory frameworks and can contribute to
the development of frameworks and standards for green finance. These frameworks
can help promote transparency, standardization, and integrity in the green finance
market.
Over the years, Reserve Bank, has been taking various policy measures to promote
and support green finance initiatives. For example, finance to renewable energy
projects have been included as a part of Priority Sector Lending (PSL) portfolio of
banks. Earlier this year the Reserve Bank supported Government of India in
successfully issuing sovereign green bonds (SGrBs). The proceeds of the SGrBs are
intended to be deployed in public sector projects which will help in reducing the carbon
intensity of the economy. The issuance of SrGBs would also help in price discovery for
other financial instruments and give a fillip to development of a market for green
financing ecosystem in the country.
Recognising that climate change can translate into climate-related financial risks for
Regulated Entities (REs) and that it can also have broader financial stability
implications, the Reserve Bank had brought out a discussion paper in July 2022 to elicit
views from all the stakeholders. Based on the feedback and suggestions received, we
have issued the instructions for acceptance of 'Green Deposits' while a disclosure
framework on 'Climate-related Financial Risks' and guidance on Climate 'Scenario
Analysis and Stress Testing' is also under works. The recently released Report on
Currency and Finance, 2022-23 with the theme 'Towards a Cleaner Greener India',
has examined the macro-financial implications of climate change and the possible
fiscal, monetary, regulatory, and other policy options for India.
Global understanding of systemic impact of climate change on the economy and the
financial system is evolving and, accordingly, the responses of central banks and
supervisors around the world have also been developing. We need to undertake a
largescale capacity building effort to equip central banks, financial firms, real economy
players to understand, assess and plan for the climate issues and related financial
risks. Only then would they be able to innovate, make strategic decisions, mobilise
capital and build effective transition plans for achieving sustainability targets. One very
important aspect of this capacity building is going to be the handholding of the smaller
firms and MSMEs to make it easier for them to navigate the transition.
Another point to note is that we all are in the same boat and action of any one entity will
have consequences for all. Therefore, global co-operation and collective efforts are very
important. An important factor in finding a solution to manage the climate risk is that it
needs to account for emission contributions of countries in the past. When we measure
the per capita emission instead of absolute emission or consider consumption-based
emissions instead of production-based emissions, the high-income countries stand out
for their contribution in global CO2 emissions. Unfortunately, it is also a reality that,
while we all face the fury of the climate change, middle and lower income countries
bear a disproportionate share of the costs in terms of loss in production capacity,
property damage & wealth loss and impact on general health and well-being. Any
solution, therefore, must factor the cumulative carbon space used by countries.
On ground, implementation of various climate finance commitments from advanced
economies has been far from satisfactory and the gap between what is being done and
what needs to be done is only growing. As against the amount of US$ 100 billion
pledged by advanced economies, only US$ 83.3 billion has been provided in 2020, an
increase of just 4 per cent from 2019. This trend needs to reverse.
To conclude, dealing with climate change is going to be a long haul for all of us. There
are going to be situations and circumstances when other issues and concerns may
come into focus and get prioritized, but we should not lose sight of long-term goal of
planned and coordinated efforts to deal with the impacts of climate change. The earlier
we all act, the better the outcome.
Thank you.
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