RBI Steps In To Check On Climate Risks In Banks And NBFCs

The Reserve Bank of India, on Feb. 28, issued a draft regulation titled Draft Disclosure Framework on Climate-related Financial Risks, 2024. This was long-awaited following the release of a discussion paper, Discussion Paper on Climate Risk and Sustainable Finance, by the RBI in July 2022. The draft provides a framework for the RBI-regulated entities (banks and NBFCs) to disclose climate-related financial risks.

The covered entities include all scheduled commercial banks (excluding local-area banks, payments banks and regional rural banks), all tier-IV primary urban co-operative Banks, all all-India financial institutions (viz. EXIM Bank, Nabard, NaBFID, NHB and SIDBI), all top and upper layer non-banking financial companies, and all foreign banks (for their operations within India). The UCBs will start disclosing in FY27 and the rest in FY26. The disclosures must be made as part of the entity's financial results/statements on its website. The disclosures must be on a standalone basis and assurance is optional.

The draft is built around the recommendations of the Task Force on Climate-related Financial Disclosures. The TCFD was set up in 2015 by the Financial Stability Board, a not-for-profit association under the aegis of G20, to develop recommendations on the types of disclosures that companies should make to help investors assess and price climate-related risks. In 2017, the TCFD released the Recommendations of the Task Force on Climate-related Financial Disclosures. The TCFD recommendations are structured around governance, strategy, risk management, and metrics and targets — the four pillars that represent the core of business operations. The TCFD recommendations include recommended disclosures under each of the four pillars. The TCFD has been disbanded since October 2023 and the FSB has asked the IFRS Foundation to take over the programme.

Climate risks have topped the Global Risks Reports of the World Economic Forum for many years now. Climate-related financial risks include physical risks (risks to assets, lives and business continuity) resulting from climate-change events and transition risks (markets, products and technology, regulatory and legal, and reputational) resulting from the low-carbon transition.

No sector or industry is safe from climate risks. The banks and the NBFCs, with their exposure across the sectors, carry significant climate risks. These risks, under certain scenarios, can affect the stability of a financial institution or even the financial system of a country. The TCFD recommendations provide sector-agnostic guidance to map, assess, and manage the climate-related financial risks (and opportunities) and integrate the risks into business strategy.

Since its release, the TCFD recommendations have been voluntarily adopted by hundreds of companies across the world, including 55 in India. Many jurisdictions, including the UK, Switzerland, Japan, New Zealand, Thailand, Malaysia, Philippines, Brazil, Columbia, Egypt, Kenya, US and Canada, have mandated TCFD-aligned disclosures. India will join them when the RBI draft becomes a regulation. It may be noted that the Business Responsibility and Sustainability Reporting mandate by SEBI does not incorporate TCFD recommendations, except Scope 1, 2, and 3 emission data reporting.

The draft regulation, when implemented, will help the RBI to have a consolidated view of the climate-related financial risk landscape among its regulated entities and enable further guidelines and regulations to navigate those risks without compromising the financial stability or the growth agenda of the country. It will help the regulated entities themselves understand their climate-related risk profiles, manage risks, and be the driving force behind the country's net-zero transition.

However, arriving at risk profiles that can be relied on to make business strategies or national policies will take a long and arduous journey for the regulated entities. Every step of what is required to be done poses a challenge. The biggest challenge that the REs face come from the key input-providing actions: one is the disclosure of aggregate financed emissions covering 100% of gross exposure and the other is the risk assessment and scenario analysis. These require emission data gathering and risk mapping of existing loans/investments and SOPs to ensure that risk assessment and emission data reporting constitute an integral part of all new loans and investments.

The challenge with respect to emission data lies in the fact that data must come from clients across sectors, asset classes, and scales that are spread across the country. The challenge with respect to risk mapping relates to the types of risks (physical and transition risks) that vary across locations and sectors. Aligning business strategy to climate risks and opportunities and setting appropriate targets and metrics for tracking and measurement will be relatively easier once robust inputs become available from emission data and risk mapping. The regulated entities must ramp up the governance to tie-in all these through appropriate oversight, policies, internal controls, and systems & procedures. To make all this a reality, the entities will require subject knowledge and skills across its employee ladder. That presents another challenge that regulated entities must deal with early on.

The draft is under public comment period until April 30, 2024. It may take a few months for this draft to become a regulation, leaving very little preparation time before the proposed compliance year FY2025–26. Therefore, it will serve the regulated entities well to view this as impending regulation and act now.

Bose Varghese is a senior director–environmental, social, and governance at Cyril Amarchand Mangaldas.

The views expressed here are those of the author and do not necessarily represent the views of NDTV Profit or its editorial team.