The world is no stranger to climate change, with phenomena like floods, droughts, wildfires and more happening simultaneously worldwide. A recent study by CarbonBrief stated that a 1.5-to-2-degree temperature increase will shave nearly 8 to 13 percent off the global GDP by the year 2100.

Banks all around the world are now recognising climate change as a source of financial risk. The uncertainty about the timing and severity of climate-related and environmental risk certainly threatens the safety, soundness, and resilience of individual Regulated Entities (REs) and, in turn, the stability of the overall financial system.

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Majorly, there are three types of sources of climate-related risks:

Physical risks refer to the economic costs and financial losses resulting from the increasing severity and frequency of:

Extreme climate change-related weather events such as heatwaves, landslides, floods, wildfires and storms

Longer-term gradual shifts in climate such as changes in precipitation, extreme weather variability, ocean acidification, and rising sea levels and average temperatures

Indirect effects of climate change such as loss of ecosystem services (such as desertification, water shortage, degradation of soil quality or marine ecology).

Transition risks are the risks related to the process of adjustment toward a low-carbon economy.

Liability risks are those arising from people or businesses seeking compensation for losses suffered from physical and transition risks.

The Reserve Bank of India (RBI) conducted a survey of 34 scheduled commercial banks on ‘Climate Risk and Sustainable Finance’ in January 2022 to assess their preparedness in this regard.

The report found that two out of three surveyed foreign banks considered climate-related financial risks as a material threat to their business, while four out of 12 public sector banks and seven out of 16 private sector banks had yet to consider the risks as a material threat.

According to the report, all the surveyed foreign banks and some private sector banks said that they handled potential physical and transition risks by integrating them into their risk management framework. Some of the public sector banks said that they factored the physical and transition risks into their Internal Capital Adequacy Assessment Process (ICAAP), but had yet to integrate climate-related risks into their overall risk management framework.

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In the case of liability risks, almost all surveyed foreign banks said that they recognised the potential liability risks arising from climate change in their risk assessment framework. Public sector and private sector banks could also consider factoring in the potential liability risks arising from climate change into their risk assessment framework.

The survey also showed that while most of the foreign banks had discussed risks and opportunities related to climate change and sustainability during the previous and current financial years, some of the public sector and a majority of the private sector banks had not done so.

Recognising that climate-related financial risks may pose threats to global financial stability, the Financial Stability Board (FSB) is ensuring that a roadmap is properly reflected in all financial decisions. The roadmap supports international coordination by bringing together the work of international organisations and national authorities on the various initiatives.

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Given the increasing climate-change risks at hand and most public and private sector banks not recognising it, the RBI intends to prepare a strategy based on global best practices on mitigating the adverse impacts of climate change, learnings from participation in standard-setting bodies and other international fora. The broad thrust of the strategy is presented under the following heads:

Overview of climate-related risk and its unique characteristics as applicable to REs

Broad guidance for all REs to have appropriate governance, strategy to address climate change risks and risk management structure to effectively manage them from a micro-prudential perspective

Exploring how forward-looking tools like stress testing and climate scenario analysis can be used to identify and assess vulnerabilities in REs

Climate-risk-related financial disclosure and reporting for REs

Capacity Building

Voluntary Initiatives