The Reserve Bank of India (RBI) recently released its semi-annual financial stability report, highlighting an important yet often overlooked threat to the country’s financial system: climate change. Despite a decline in loan defaults to a multi-year low, the report underscored that the risk posed by climate change has become a major concern among financial institutions.
Climate Change: The New Systemic Risk
For the first time, respondents in the RBI’s survey identified climate change as the greatest source of systemic risk to India’s financial system. This marks a significant shift in focus from traditional concerns such as asset quality, interest rate risk, and capital outflows. The rising recognition of climate change as a critical issue is not unfounded. According to the Network for Greening the Financial System, India’s economic growth will suffer unless global temperature rises are controlled. This vulnerability extends to key sectors like construction, cement, and energy, to which Indian banks are heavily exposed.
Regulatory Response and Bureaucratic Inertia
Indian regulators have been slow to respond to the growing threat of climate change. It was only earlier this year that the RBI introduced a draft framework requiring financial institutions to develop and disclose strategies to mitigate climate-related risks. However, the implementation timeline is generous, with the new rules set to take full effect only by the financial year ending in March 2028.
This delay is partly due to bureaucratic inertia and the fear of overlapping jurisdictions. There is still no consensus on what qualifies as “green” investment. While the securities market regulator has attempted to define a taxonomy and reporting framework for large publicly traded companies, the finance ministry prefers a centrally decided taxonomy. An inter-departmental task force established in 2021 has yet to finalize definitions, reflecting the slow pace of regulatory progress.
Learning from Global Standards
India’s regulatory approach appears to be somewhat insular, with policymakers often believing they have little to learn from international standards. However, aligning India’s criteria with global practices in areas such as taxonomy, disclosure requirements, and climate stress tests could enhance transparency and attract global investors. Despite the skepticism, adopting such standards could be crucial for improving investor confidence in India’s financial system.
Challenges in Green Finance
Indian policymakers remain doubtful about the promises of global sustainable finance. This skepticism was evident when India launched a sovereign green bond in 2023, which saw limited interest from foreign investors and was predominantly bought by domestic investors. Consequently, the RBI canceled a planned second tranche for this year.
The hesitation to fully embrace green finance may also stem from an underlying fear of what a stringent examination of climate risks might reveal. Preliminary climate stress tests conducted by the RBI in 2023 indicated that public sector banks are particularly vulnerable. These banks have historically financed the energy sector heavily, and recent data suggest they are now wary of further investments in coal-fired power plants due to overexposure. While renewables have not faced similar issues, the overall risk exposure remains a significant concern.
The Need for Accelerated Action
Five years ago, Indian regulators may not have fully appreciated the macroeconomic risks posed by climate change. Today, however, the threat is well-documented, and the path forward is clear. The RBI’s report provides exhaustive details on how other central banks and regulators are addressing climate risks, offering a roadmap that India can follow.
The urgency of the situation cannot be overstated. With climate change posing an ever-growing threat to economic stability, it is imperative for Indian regulators to expedite the implementation of robust climate strategies. The slow pace of regulatory action not only leaves the financial system vulnerable but also hampers efforts to attract global investment in green finance.
RBI’s latest financial stability report highlights a decline in loan defaults, it also brings to the forefront the significant threat posed by climate change to India’s financial system. The recognition of climate change as a systemic risk marks a critical shift in the financial sector’s priorities. However, the slow regulatory response and bureaucratic delays pose significant challenges. To safeguard the financial system and attract global investments, Indian regulators must accelerate the adoption of comprehensive climate strategies and align with international standards. The roadmap is clear; it is now up to India to act swiftly and decisively.
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