RBI Drafts Guidelines for Financials’ Climate Risk Disclosure

The Reserve Bank of India (RBI) has sent shockwaves through the financial sector with its proposal for mandatory climate-related financial risk disclosures by regulated entities. This progressive move, outlined in the draft framework titled “Disclosure Framework on Climate-related Financial Risks, 2024,” signifies a significant shift towards a more sustainable financial ecosystem in India. The increasing urgency to address climate change and its potential impact on financial stability has undoubtedly influenced the RBI’s decision.

Unveiling the Disclosure Framework

The draft framework, currently open for comments until April 30, 2024, mandates banks and Non-Banking Financial Companies (NBFCs) to disclose information on climate-related financial risks and opportunities. This transparency will empower users of financial statements, including investors, lenders, and depositors, to make informed decisions. The disclosures will encompass four key pillars, providing a comprehensive picture of an RE’s (Regulated Entity) approach to climate change:

• Governance: Financial institutions will be required to shed light on their internal structures and processes for identifying, assessing, and managing climate risks. This includes outlining roles, responsibilities, and expertise within the organization for tackling climate-related challenges. The draft goes a step further, recommending the establishment of a dedicated climate risk management committee or the designation of a senior management official to oversee climate risk initiatives.
• Strategy: The framework necessitates outlining the RE’s strategy for managing climate risks and opportunities. This encompasses articulating short, medium, and long-term plans that demonstrate the RE’s commitment to sustainability. The strategy should also address how climate scenarios, such as increased frequency and intensity of floods or droughts, will be factored into business operations and financial planning. The draft suggests scenario analysis as a potential tool for assessing the impact of climate change on the RE’s portfolio and profitability.
• Risk Management: This section delves into the specific actions that the RE is taking to mitigate climate-related financial risks. The draft encourages a multi-pronged approach, including portfolio diversification to reduce exposure to high-risk sectors or geographical locations. Risk transfer mechanisms like insurance or derivatives can also be explored. The framework even suggests developing new financial products and services that cater to a climate-conscious market, such as green bonds or loans for climate-resilient infrastructure projects.
• Metrics and Targets: Entities will be required to disclose relevant metrics for measuring and managing climate risk. This includes quantifying greenhouse gas emissions (Scopes 1, 2 & 3) to understand their environmental footprint. Additionally, setting targets for emission reduction demonstrates a proactive approach towards sustainability. The draft proposes a phased approach for disclosing metrics and targets, allowing institutions time to develop robust measurement methodologies.

Phased Implementation for a Smooth Transition

The RBI acknowledges the need for a smooth transition and has proposed a phased implementation for the disclosure requirements. The first phase, beginning in FY 2025-26, will focus on disclosures related to Governance, Strategy, and Risk Management. Disclosures on Metrics and Targets will follow a year later for commercial banks, All-India Financial Institutions (AIFIs), and NBFCs, with Urban Cooperative Banks (UCBs) implementing a year after that. This phased approach allows institutions time to develop the necessary systems and processes for comprehensive climate risk disclosure.

The Rationale Behind Climate Risk Disclosure

Climate change poses a multitude of financial risks to the banking sector. Extreme weather events can lead to a surge in loan defaults, rising sea levels can threaten coastal properties held as collateral, and potential regulatory changes due to climate action policies can disrupt business models. By mandating climate risk disclosures, the RBI aims to achieve several critical objectives:

• Enhanced Transparency and Accountability: Disclosure compels financial institutions to be transparent about their exposure to climate risks, fostering greater accountability towards stakeholders.
• Sustainable Practices Take Center Stage: Climate risk disclosure encourages financial institutions to integrate sustainability considerations into their core business practices, promoting environmentally responsible lending and investment decisions.
• Strengthening Risk Management: By requiring the identification and quantification of climate risks, the framework pushes institutions to develop robust risk management strategies for long-term stability.
• Climate-Conscious Investment Decisions: Increased transparency allows investors to assess the climate risk profile of financial institutions, enabling them to make informed and sustainable investment choices.

The RBI’s draft guidelines are a commendable step towards building a more resilient and sustainable financial system in India. By promoting transparency, risk management, and sustainable practices, these disclosures can pave the way for a future where financial stability and environmental responsibility go hand-in-hand. This future will likely see a shift towards financing activities that contribute to a low-carbon and climate-resilient economy, ultimately benefiting both the environment and the financial sector itself.

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