The green transition of the financial sector is guided by the five Rs: Risk Management, Responsibility, strategic Reset, Reporting & Disclosure, and Reallocation & Raising. Banks play a crucial role in financing the global economy amidst the challenges of climate change. Climate risks, including physical and transition risks, impact the economy and financial system, with estimates suggesting that global warming has resulted in the Indian economy staying 31% smaller than it could have been. Addressing these risks is vital for the sustainable development of the financial sector and the economy as a whole.
A study by the Network for Greening Financial System (NGFS) highlights that nature-related risks have significant macroeconomic implications and pose risks to individual financial institutions and the overall financial stability. Macroeconomic shocks can result in credit, market, liquidity, operational, legal, and reputational risks for banks, leading to capital depreciation, shifts in prices, and socio-economic changes. These risks impact various aspects such as interest rates, exchange rates, fiscal space, and more, emphasizing the need for banks to account for and mitigate nature-related risks in their operations.
To internalise environmental externalities and reduce risk perceptions, green finance was introduced. Green finance covers a wide range of financial products and services, from investment, and banking to insurance products. According to the Green Finance Platform, banking forms the second largest asset class globally. The Asian Development Bank estimates that USD 3.6 trillion is specifically required for climate change mitigation and adaptation in developing member countries. By conservative estimates, the current tracked green finance in India represents approximately 25% of the total requirement across sectors just to meet the Nationally Determined Contributions. India needs approximately INR 162.5 lakh crores (USD 2.5 trillion) till 2030 for NDCs and INR 716 lakh crores (USD 10.1 trillion) to achieve Net-Zero emissions by 2070.(Landscape of Green Finance in India 2022. Climate Policy Initiative)
India started emphasising on green finance as early as 2007. In December 2007, the Reserve Bank issued a notification on “Corporate Social Responsibility, Sustainable Development and Non-financial Reporting – Role of Banks” that highlights the importance of global warming and climate change in the context of sustainable development. Banks in India are going green through either their own operations or by deploying financial instruments like green bonds and loans. Reserve Bank of India (RBI) has introduced a Framework for the acceptance of Green Deposits for regulated entities, which will come into effect from June 1, 2023. The objective is to protect depositors’ interests, aid customers in achieving sustainability goals, and address greenwashing concerns. RBI also established Green Coin Ratings to evaluate banks based on their carbon emissions, reuse, refurbishment, recycling efforts, financing of green projects, and recognition for promoting environmental initiatives. These efforts aim to promote green financing and incentivize banks to adopt sustainable practices.
Banks in India have prioritized lending to renewable energy projects since 2015. SBI and the European Investment Bank launched a €100 million initiative for climate action and sustainable businesses. Indian Renewable Energy Development Agency (IREDA) became India’s first ‘green bank’ in 2016 (May). These initiatives aim to boost green investments, address climate challenges, and promote sustainable banking practices.
While there have been improvements in public awareness and financing options, the major challenges are false claims of environmental compliance, the plurality of green loan definitions, and maturity mismatches between long-term green investments and relatively short-term interests of investors.To deal with these challenges and more, banks need to be proactive in policy reforms and adopting a green taxonomy.
Pic credit- Jasmine Kaur
As a first step, Banks need to reform their governance structures. The Board of Directors need to play a critical role in identifying and assessing climate-related and environmental risks as well as implementation and oversight of risk management strategy. The risk management framework (risk appetite statement, risk management strategy and business plan) needs to be properly formulated, planned and implemented. It shall include quantitative and qualitative indicators like the concentration in CO2 / GHG-intensive assets and the Carbon emission footprint of the portfolio. The impact of risk on overall business strategy in the short, medium and long term needs to be understood.
Secondly, steps need to be taken for capacity building and upskilling of the Board and Senior Management on climate-related issues through internal workshops and training, or external collaboration. It is essential that the management has a sufficient understanding of climate-related financial risks and is equipped with the capabilities to deal with these risks.
Thirdly, banks need to incorporate an assessment of both physical and transition risks across a range of climate-related scenarios. Under these scenarios, resilience to financial losses has to be understood and mitigation measures planned.
Lastly, banks need to adopt climate-related financial disclosures. It helps to understand relevant risks faced by it and their approach to addressing such issues. It will improve internal due diligence and impose discipline that may ultimately lead to better risk management. Robust disclosures can improve the pricing mechanisms for climate-related risks. It may also facilitate identification and capitalisation on climate-related opportunities for market participants, thereby contributing to the scaling up of green finance.
Green Financing Instruments introduced in India
- Green Bonds: Indian companies and financial institutions have increasingly issued green bonds to raise funds for renewable energy, energy efficiency, and other environmentally beneficial projects. Green bonds provide investors with the opportunity to finance green initiatives while generating financial returns.
- Green Loans: Financial institutions in India have introduced green loan products specifically designed for renewable energy projects and sustainable initiatives. These loans offer favorable terms and conditions to encourage businesses to adopt green practices and invest in environmentally friendly technologies.
- Green Microfinance: Microfinance institutions in India have started incorporating green finance principles into their lending operations. They provide microloans to individuals and small businesses for eco-friendly activities such as clean energy solutions, organic farming, and sustainable livelihood projects.
- Sustainability-Linked Loans: These loans tie the interest rate charged to the borrower’s sustainability performance. If the borrower achieves pre-defined sustainability targets, the interest rate is reduced, incentivizing sustainable practices and projects.
- Green Venture Capital and Private Equity: Venture capital and private equity funds focused on green and sustainable investments have emerged in India. These funds provide capital to early-stage and growth-stage companies working on renewable energy, clean technology, and sustainable solutions.
- Green Insurance: Insurance companies in India have started offering specialized insurance products to cover risks associated with renewable energy projects, energy efficiency retrofits, and climate-related events. This helps mitigate risks for investors and project developers, encouraging more investments in green initiatives.
- Green Rating and Certification: Financial institutions have introduced green rating and certification frameworks to assess the sustainability performance of companies and projects. These frameworks provide transparency and credibility, allowing investors to make informed decisions about financing green projects.
Jasmine Kaur is a Senior Fellow at CGAPP working under Circular Economy vertical.She is currently pursuing Environmental law from NLU,Delhi.
Megha Nath works as a Program Manager at Institute for Sustainable Communities (ISC). She holds a degree an MSc in Environmental Economics from Madras School Economics.
