The Reserve Bank of India (RBI), India’s central bank, is soon setting regulations to encourage the nation’s lenders and regulated entities (REs)to take steps, including increasing green lending, to mitigate risks emerging from climate change.

Stressing that these announcements are a first set of measures, RBI governor Mr Shaktikanta Das, while announcing the RBI’s Monetary Policy Committee’s interest rate decision last week, added that few more measures would follow. Mr Das brought this focus on amid India’s thrust to power sustainable financing to fund green projects. India sold its first tranche of sovereign green bonds in January.

Mr Das said, “Recognising the importance of climate related financial risks which may have financial stability implications, the Reserve Bank had issued a Discussion Paper on Climate Risk and Sustainable Finance in July 2022. Based on the feedback received, it has been decided to issue guidelines for REs on a broad framework for acceptance of green deposits; disclosure framework on climate-related financial risks; and guidance on climate scenario analysis and stress testing. “He added, “These measures together will ensure that India’s financial system starts to build resilience to withstand any possible vulnerability to climate change,” stressing that this move is a timely one.

The 2022 RBI Discussion Paper had pointed out that climate-related risks refer to the potential risks that may arise from climate change or from efforts to mitigate climate change, their related impact and the economic and financial consequences. It can impact the financial sector through two broad channels i.e., physical risks and transition risks.

Physical risks refer to the economic costs and financial losses resulting from the increasing frequency and severity of extreme climate change-related weather events, longer-term gradual shifts of the climate, and indirect effects of climate change. Physical risk impacts depend on geographical locations, as different regions display varied climate patterns.

Transition risks refer to the risks arising from the process of adjustment towards a low-carbon economy. A range of factors influences this adjustment, including changes in climate-related policies and regulations, the emergence of newer technologies, shifting sentiments and behaviour of customers. The process of transition may have a significant impact on the economy. Transition risk drivers can include climate related mitigation policies could include reduction in financial valuation or downgrade in credit ratings of businesses adversely affecting the climate or introduction of subsidies to encourage the use of energy efficient goods/processes. Technological advances can contribute to energy transition, increase the use of non-fossil fuels that reduce greenhouse gas emissions. Shifts in public sentiment including that of consumers and investors can affect the economy and financial system.

According to a 2021 RBI bulletin, green finance is fast emerging as a priority for public policy. refers to the financial arrangements that are specific to the use for projects that are environmentally sustainable or projects that adopt the aspects of climate change. Environmentally sustainable projects include the production of energy from renewable sources like solar, wind, biogas, etc.; clean transportation that involves lower greenhouse gas emission; energy efficient projects like green building; waste management that includes recycling, efficient disposal and conversion to energy, etc. Projects defined as sustainable under the disclosure requirement for green debt securities include climate change adaptation, sustainable waste and water managements, sustainable land use including sustainable forestry and agriculture, and biodiversity conservation. In order to meet the financial needs for these types of projects, new financial instruments such as green bonds; carbon market instruments (e.g., carbon tax); and new financial institutions (e.g., green banks and green funds) are being established. They together constitute green finance.

The Bulletin adds that green finance is central to the overall discussion on sustainability of economic growth. Rapid economic development is often achieved at the cost of environment. Dwindling natural resources, degraded environment and rampant pollution are hazardous to public health and pose challenges to the sustainable economic growth. In order to protect and substantially improve the environment, nations around the world have been increasingly focusing on the use of eco-friendly technologies. However, it requires appropriate incentive structure for increased allocation of funds towards setting up or adopting environmentally sustainable projects. Once funds are freed from the conventional industries and are channelled into the green and environment- friendly sectors, other resources including land and labour may also follow. This eventually leads to an optimal allocation of resources that support sustainable growth in the long run. In order to achieve these objectives, targeted policies on green finance have been formed in major countries involving all stakeholders of economic growth.