India’s financial sector sleepwalking into climate crisis: Study

There have been limited efforts to identify, measure or manage low-carbon transition risks in India, finds the study

India’s budget 2023-24 is a mere few days away and all eyes are on how India will balance fiscal consolidation at a time of global economic upheaval with developmental priorities. Over the past few years, climate action and financing low-carbon development in the country have been big on the agenda, and are once again likely to pop up during budget announcements. While the country has looked to mobilise domestic and international finance through debt instruments such as the recently rolled out Sovereign Green Bonds and is currently formulating norms to evaluate ESG spends in the private sector, India’s financial sector might be far from ready to reckon the multitude of challenges posed by climate change.

This is the finding of a new study published earlier this month in the journal Global Environmental Change. According to the study, India’s financial industry is far more exposed to the hazards of the low-carbon transition than typical borrowing classifications might imply. The study examined how much transition risk the Indian financial sector was exposed to and whether financial institutions and finance professionals were doing enough to manage such risks.

Risk of sticking to a high-carbon development model

The analysis of individual loans and bonds found that oil and gas extraction accounts for three-fifths of lending to the “mining” sector, while petroleum refining and allied businesses account for one-fifth of debt in the “manufacturing” sector. The study also found that electricity production – by far the largest source of emissions – accounts for 5.2% of outstanding credit, but that only 17.5% of this lending is to pureplay renewables.

Other carbon-intensive industries, such as civil aviation, cement, chemicals, iron and steel, mining and quarrying, oil and gas extraction, and petroleum refining, account for another 6% of the nation’s outstanding debt, although the analysis showed that they have also borrowed heavily in foreign currency-denominated loans and bonds and, therefore, presumably from international financiers.

Most loans and bonds have a short- or medium-term maturity, so the ability to repay them won’t likely be threatened by new environmental regulations or shifting economic conditions. However, the study noted that lending for fossil fuel production and power generation in India today far outpaces lending for renewable energy technologies despite the latter’s improving economics. 

If these financial trends were to continue, the study warned, they risk causing or perpetuating “lock in” to high-carbon development, both because of the long life of the physical infrastructure that is being financed and because of the consolidation of policies, practices, norms and networks that sustain lending patterns. 

The report warned that these financial trends run the risk of creating or maintaining a “lock in” to high-carbon development due to the extended lifespan of the infrastructure that is being financed, along with the consolidation of laws, customs, norms, and networks that support these lending patterns.

Limited efforts by financial institutions

The study found that the efforts to identify, measure or manage low-carbon transition risks in the country have been limited. Fewer than half of the 154 finance professionals surveyed were familiar with environmental issues including climate change mitigation and adaptation, greenhouse gas emissions or transition risks.

Only four of the ten largest financial institutions studied gather data on ESG risks, and these companies do not systematically use that information for business continuity planning, internal processes for determining capital adequacy, credit risk evaluations, enterprise risk management frameworks, or loan product pricing.

Mapping India’s policy commitments and global temperature targets against the analysis of borrowing and bond issuance revealed that India’s financial sector is heavily exposed to potential transition risks. To remedy the situation, the study recommended an intervention by central banks and supervisors to explore their role in accelerating the low-carbon transition and managing its possible risks. The starting point for many central banks is mandatory disclosure of low-carbon transition risks. The engagement and actions of central banks both legitimise and reinforce expectations of a carbon-constrained future. Changing financiers’ perceptions of risk can help to constrain the development of fossil fuel assets, which in turn reinforces the credibility of carbon constraints, added the study.  

There’s a need for enhanced transparency in India as the standard sectoral classifications conceal the carbon intensity of lending and investment, said the study. 

The study also recommended developing India-specific climate risk scenarios and undertaking stress tests based on new policy commitments and revising capital adequacy rations to incentive financial institutions to reduce lending to and investment in carbon-intensive sectors.

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