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Need for a policy framework to assess climate risk on financial stability: RBI

By on July 3, 2021 0

Bombay: The risk of climate change to financial stability is increasing and an appropriate policy framework is needed to identify, assess and manage this risk, according to the Reserve Bank of India. In its financial stability report, RBI said some central banks have started to prepare to monitor and manage climate risks.

The Bank of England, for example, has announced its intention to undertake a biennial scenario analysis to test the resilience of the financial system to physical and transition risks associated with different climate trajectories. The Banque de France has also started to take into account the high-level scenarios proposed by the Network of Central Banks and Supervisory Authorities for the Greening of the Financial System (NGFS). Launched at the One Planet Summit in Paris in December 2017, the NGFS is a group of central banks and supervisors willing to share best practices and contribute to the development of environmental and climate risk management in the financial sector, while mobilizing mainstream finance to support the transition. towards a sustainable economy. RBI joined NGFS as a member central bank in April 2021.

RBI also called for a cross-sector disciplinary forum to launch a comprehensive climate risk assessment exercise for India. As a prerequisite, India needs to develop emission reduction pathways for energy intensive sectors and map them to macroeconomic and financial variables and integrate them with quantitative disclosures related to climate risks in order to develop a holistic approach to address financial stability risks resulting from climate change.

According to Emkay Research, this may indicate the need for a long-term comprehensive environmental, social and governance policy framework, which increases the cost of doing business. Indian banks’ loan portfolios (mainly corporate sectors such as power, infrastructure, metals, automotive and chemicals / paper; vehicles in retail) remain vulnerable to downside risks. growth / quality of assets linked to climate change in the long term, and therefore must be addressed, It said.

According to the FSR report, climate risk stress tests are different from the traditional regulatory framework for stress tests in terms of time horizon, frequency of reporting, sector specificity, modeling approach and nature of the results. Attempts to quantify climate risks to the financial system can take two forms – top-down and bottom-up. In a top-down approach, the magnitude of risks can be estimated using the sensitivity of the banking system’s physical risk exposures based on geography and transition risk based primarily on the sector’s carbon emissions. In the bottom-up alternative approach, financial institutions themselves calculate the impact of climate risk on their respective portfolios on the basis of a common scenario specified by the central bank.

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