The biggest change that will reflect in the risk disclosure will provide a flavour to the stakeholders on how climate related financial risks have resulted in the improvement of processes on an annual basis
Alignment with ESG disclosure requirements has leapfrogged over the last couple of years. A recent addition to this is a draft disclosure framework presented by the Reserve Bank of India (RBI) on February 28, 2024, for regulated banks on mandatory disclosure of climate related financial risks and opportunities based on the four pillars of IFRS S-1 i.e., Governance, Strategy, Risk Management, and metrics and targets. The disclosure framework introduced a glide path for disclosures. The information on governance, strategy, and risk management is required from fiscal 2026, while that on metrics and targets is from fiscal 2028. For tier IV primary (urban) co-operative banks, the applicability has been deferred by a year.
The central bank has proposed disclosure coverage for:
- Scheduled commercial banks (excluding local area banks, payments banks and regional rural banks)
- Tier IV primary (urban) co-operative banks
- All-India financial institutions
- Top and upper layer non-banking financial companies
The RBI expects regulated entities (REs, i.e., entities obliged to disclose) to establish appropriate governance structures for identification, analysis, oversight, and disclosures. The broad expectation is to have a committee, while in lean setups, even individuals may discharge the set-out responsibilities. The draft guidance also indicates that banks may consider adopting climate-related financial disclosures. The Task Force on climate-related Disclosures (TCFD) is one of the foremost and globally adopted protocols for such disclosures. In the absence of any domestic financial disclosure standard, institutions can consider aligning with TCFD as a fallback.
While the banking sector assumes disclosure responsibilities, the outcome may trigger additional capital adequacy requirements. Institutions with high exposure to climate risk may be mandated to increase the capital adequacy ratio (CAR). At present, Indian public sector banks maintain a CAR of 12 percent, while scheduled banks maintain 9 percent. CAR ensures that a layer of safety is present for a bank to manage its own risk weighted assets before it can manage its depositors' assets. This ensures that depositors have an additional safeguard.
The second important aspect of disclosures will require banks to recalibrate their strategies short, medium and long-term impacts on their financial exposures. It is important to note that the revised Nationally Determined Contributions (NDCs) will have a wider coverage across sectors that are covered under the present “Perform, Achieve, & Trade (PAT)” scheme, as well as the domestic carbon markets under CCTS 2023, which will provide opportunities to develop mitigation projects through obligated and non-obligated entities. Financial institutions will have to thus rebuild their risk approach based on plain vanilla exposures, exposures with emission reduction opportunities for domestic and international markets, i.e., as per the provisions of Articles 6.2, 6.4, and 6.8 of the Paris Agreement. This may create a paradigm shift across the banking and financial sectors in the country.
The draft issued by RBI has also introduced the concept of double materiality as an underpinning to risk management, something that has been introduced in the “European Union Corporate Sustainability Reporting Directive (CSRD),” which is applicable to large businesses as well as public interest entities. The biggest change that will reflect in the risk disclosure will provide a flavour to the stakeholders on how climate related financial risks have resulted in the improvement of processes on an annual basis.
The matrices and targets, which will apply from FY 2028, are expected to bring in regimented disclosures on greenhouse gas (GHG) emissions in complete alignment with ISO 14064, thereby ensuring that targets go beyond Scope 1 and 2 emissions and include Scope 3 emissions as well. A larger market for GHG Protocol Chapter 15 will be visible across the banking and financial sectors that will be covered by the proposed regulations. It will also democratise the way in which institutions look at physical (direct consequences of climate change) and transitional risks (policy changes) for their financial exposures. On the flip side, this may also result in credit risk for institutions where depositors believe that the value of assets can depreciate, including the long-term supply chain impacts on the debtor’s ability to repay, downgrades in credit ratings, as well as possible exposures in conventional power production. The decision of the International Finance Corporation (IFC) to fund coal projects mirrors the thoughts put forth in the draft prepared by the RBI.
The central bank’s approach to financial risks emanates from global decisions around curbing the temperature rise below 2 degrees and its overall implementation across geographies. Its aim is to enhance the resilience of India’s financial system, which will play a critical role in supporting the transition to a sustainable economy. It may also provide a heads up to financial institutions on the tradeoff between short term financial gains and long-term growth and business sustenance by adopting low carbon pathway for financing emissions. A robust adoption of disclosures around financial risk will also attract investors and global flow of funds for India’s decarbonisation journey, a country that may be home to nearly 20 percent of the global population by mid-century.
(Inderjeet Singh, Partner, Financial Advisory at Deloitte India)