Climate risks call for a green financial system: The Tribune India


Ajay Sagar, financial analyst

The CLIMATE risk constitutes a major challenge for a country’s financial system, which worries regulators. Investors assess climate risks when making investment decisions. Banks are feeling the pressure to offer green deposits, investment products and credit. Serious questions are emerging. What will my pension fund’s balance sheet look like when I retire? How will the savings and deposits in my life contribute to climate change? Are current corporate disclosures meaningful or just a patchwork? Do they achieve the purpose for which they were created? How will stakeholders understand a company’s emissions? How will carbon emissions be aggregated and reported?

Are climate risks in the financial system the responsibility of a central bank or the federal government? Are political institutions best placed to deal with climate-related financial stability issues? Despite divergent views, there is a consensus that the financial system is exposed to systemic risks from extreme weather events requiring central banks to be prepared. Adverse weather events could potentially shift a large chunk of the economy onto a central bank’s balance sheet. There is an urgent need to develop a long-term action plan to deal with a transition beyond the political mandate of an elected government. The need is to identify potential climate risks that can hamper a country’s financial system, infrastructure and housing investments.

Climate risks are uncertain and irreversible. With increasing frequency and severity, climate disasters have the potential to disrupt economic activity, the financial system, monetary policy, price stability, inflation, and interest rates. Any corresponding reduction in asset values ​​will impact banks, investors, lenders and capital markets. Payments and the clearing system could be affected. The challenge is unique. Recognizing this, financial regulators around the world have voluntarily established a Network for Greening the Financial System (NGFS). This consensus-driven forum is mandated to share best practices for fostering a greener financial system.

Despite the recognition of climate risks and the increase in temperature, the response of stakeholders over the past decades has been dominated by hype, environmental damage and “greenwashing”, generating the public distrust. The word “greenwash” entered the dictionary in the 20th century. This means the dissemination of disinformation to present a responsible public image of the environment. The global governance agenda needs to urgently address the lack of environmental sincerity. Investors need to be equipped with tools, instruments and products to make climate smart investments. Rating agencies have now launched an ESG (environmental, social and corporate governance) assessment initiative due to the growing demand to apply an ESG lens to investing. Underwriting standards must be revised to take into account climatic risks.

Supervisors should promote investor awareness, research into climate-friendly investments, green bond listing and facilitate retail green deposits. Despite rapid growth in the volume of green bond issuance, the market is still in its infancy and lacks certification, product use and disclosure metrics. The standards developed so far lack any regulatory support. The Swiss-based Bank for International Settlements (BIS) has advocated for the development of a carbon intensity rating system at the company level. Regulators are working on common guidelines for issuing and certifying green bonds. The EU proposed a draft standard on green bonds for voluntary compliance. The UN has mandated a Task Force of Chief Financial Officers (CFOs) to provide recommendations for mainstreaming sustainable investments. International rating agencies are preparing to integrate climate risk into the allocation of sovereign risk ratings. A standstill approach, relying on implicit or explicit guarantees to depositors, will not suffice. Globally, a few regulators have started to work on the link between bank deposit insurance and green settings. Central banks are examining options to shift risk weighting on securities and reserves in favor of green investment.

A recent IMF study pointed out that the physical risk of climate change does not appear to be reflected in global equity valuations. Current asset values ​​may be lacking on climate risks. Seeing the benefits, the private sector is playing a central role in building climate resilience. Big Indian conglomerate Reliance recently gave a timeline to become carbon neutral by 2035, well ahead of BP Shell’s 2050 timeline. HDFC bank has said it intends to become carbon neutral by 2032. The benefits are growing. Present in the form of brand value creation, skills enhancement and retention, improved employee morale, access to capital markets and increased market capitalization. Corporate boards could become climate savvy by educating themselves about climate governance to fulfill their oversight and leadership role. Recently, the New York insurance regulator mandated insurers to strengthen governance by creating a board committee or senior official to address potential climate risks in credit and risk assessments.

Merely AAA rating of central bank reserves is not enough. The financial security of reserves is incomplete if it is not combined with security against climate risks. Central banks must now invest in climate resilient AAA reserves that offer the highest degree of security and are liquid. The charity starts at home, and Ireland’s central bank has taken the first step by disclosing its investment in green bonds. This initiative will help reflect the true valuations of assets by capturing the financial risks associated with climate risks. Insurers, private equity funds, pension funds and hedge funds now require climate-related financial information.

Previously, 100 institutional investors with $ 1.8 trillion in assets had asked the 60 largest banks for solid information on climate risks. Quality information could convincingly steer the free will of investors towards green investing. Central banks are examining the possibility of equating or giving climate-related data the same status as accounting disclosure. There is also a tendency to consider pricing carbon risk in the context of syndicated bank loans. Carbon intensity data can help capture the severity of the financial impact of tightening carbon emission policies.

It is essential to better assess and address concentrations of climate risks, as financial systems can be under-prepared. Monetary policy affects the behavior of stakeholders and economic activity. It must now reflect a green footprint away from fossil fuels. Is the RBI ready for a green monetary policy? Indian financial regulators will soon have to start publicizing their position on climate-related financial stability risks. Postponing a green monetary policy is no longer an option. The IMF has started engaging countries in assessing the stability risk arising from climate risks. NITI Aayog could help coordinate the initiative. Left unchecked, a transition risk can cause ripples in the financial system and market failures. India must be at the forefront of the financial sector greening agenda.


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