Global warming and climate change is increasingly being recognized as a significant Financial Stability risk concerning Governments and Industry world over.
The physical impact of climate change like increasing temperature, water scarcity and unpredictable weather conditions are bound to have a cascading effect and adverse impact on global economic activity.
As a case in point, The World Economic Forum ranked ‘Extreme weather events and failure of climate-change mitigation and adaptation’ among the top risks – both in terms of its likelihood and impact. The implications of this on people, business and society are far reaching and India too will face specific challenges in the coming years. As the potential economic ramifications of this risk become clearer, the many challenges and opportunities facing the BSFI industry in India merit wider debate and discussion.
Measuring it up
• On ground real time challenges: These are ongoing challenges caused by increasingly frequent climate and weather-related events – such as severe droughts or heavy rains/cyclones that affect crops. These events will not only impact the business operations of an industry but can also have cyclical impact on the other industries as well because the entire ecosystem in the present scenarios is interconnected.
• Transition: One such example is when a business moves away from carbon- intensive industries and technologies in a knee jerk reaction and chaotic manner, their business models and asset valuations in all probability will end up taking a big hit.
• Unexpected Liabilities for Insurers: When people or businesses claim compensation for losses suffered from either of the above risks, this can have a huge impact on insurers.
Clearly, as temperatures and sea levels rise, banks and insurers will be under greater pressure by being exposed to potentially large and unexpected payouts
Climate compliance and regulatory response
The European Central Bank has formally identified climate-related risk as one of the key risks facing the banking sector. It computes the impact of climate-related changes on banks’ capital positions, and, ultimately, on the supply of funds to the economy. Similarly, The People’s Bank of China considers environmental factors in its monetary policy framework and financial stability assessments.
In Brazil, the Central Bank requires banks to factor in environmental risks while computing capital requirements. It is important to appreciate that such regulations will become more important as we see a move from current voluntary schemes to climate-related risks becoming a more central part of regulation and rating agency assessments.
In India, until a few years ago, the topic of climate change and related risks rarely found strong traction in the BFSI sector in India. Till date, most banks and insurers still do not take a sufficiently forward- looking view on climate change and its long-term financial impact. The Financial Stability Board published the second status report on adoption of the recommendations of the Task Force for Climate-related Financial Disclosures on June 5, 2019. The report observed that disclosure of climate-related financial information has increased since 2016, but is still insufficient for investors, especially on the financial impact of climate-related issues on companies..
It is apparent that banks will need to come out with a clear policy going forward and will also need to be prepared in the monitoring of climate-related risks. They will also require identifying key stakeholders and put in place well documented processes to manage this risk while being prepared for likely implications.
For instance, investments and industry exposure will require risk screening that includes climate change impact at local level as it can vary significantly by the geography and sector.
The Reserve Bank of India, in its recent report acknowledged that policy action is needed to set up an enabling framework to promote green financing in India. The report says that green finance offers new opportunities for diversification of financial assets and enhances the ability of the financial system to mobilize private capital for a more sustainable low-carbon economy. However, the regulator also expressed concern towards facing green governance including false compliance claims, non-standard definitions of what constitutes green loans, and maturity mismatches between long-term green investment and relatively short-term interests of investors.
Assessing and addressing the rising threat
Reports suggest that with over 25% of the world population living in coastal zones and with 12 out of 16 megacities of the world located on coastal land, there could be a large financial burden and credit risk for Banks and Insurers.
Being an omnipresent threat facing the world, governments, policy makers and regulators are expected to play a pivotal role in providing a policy framework, but at the same time the role of the BFSI sector in risk assessment, protection and recovery simply cannot be understated. The entire BFSI sector should collaborate and develop innovative solutions to manage and mitigate risks arising out of climate change.
Getting your own house in order first is crucial and the financial services sector need to make sure their own balance sheets are environmentally sustainable, making public any data they have on climate-related risks and review their partnerships with organizations which do not support certain minimum prescribed standards. A range of global financial services giants have identified sector-specific assets including energy, agriculture, water, information & communication technology, transportation, tourism and real estate that will have a direct bearing on their service disruption and cost escalations due to climate change. This is surely a step in the right direction.
The time is ripe for Indian Banks and FIs to take the bull by its horn and initiate some concerted efforts in this direction. According to the first edition of Fair Finance Guide India released in October last year, Indian banks failed on policies of environment and human rights. The study that scored top eight Indian banks based on their environmental, social and governance (ESG) policies inferred that climate change, human rights, labor rights and nature have taken a back seat in the banking policy domain.
Under the environment category 7 out of 8 banks scored zero and one bank scored 8%. Though it appears that there is a lot of interest in the area of environment among financial institutions in general, the banking sector is yet to align itself with the opportunities that are available.
Opportunity for the nation
The BFSI sector in India has a distinct opportunity to not only provide risk financing solutions to climate change issues, but also incentivizing and initiating strategic funding for industries that help tackle climate challenge at the very root, like for instance the renewables sector. The insurance sector can expect new opportunities for offering bespoke insurance covers apart from conventional weather derivatives and climate information products; for example, rainfall insurance, particularly in the context of significant parts of the country facing drought.
Intermediaries too, have an important role to play in building resilience. As a part of its ongoing support to the Task Force on Climate-related Financial Risk Disclosures (TCFD), Willis Towers Watson has developed an end-to-end Climate Risk Assessment framework which was launched at the World Economic Forum in Davos this year. The framework aims at utilizing analytics to price climate risk to support and incentivize the development of climate resilient infrastructure. It will also provide climate risk advice and meaningful access to the data representing possible future scenarios and their financial impacts.
Our “Climate Quantified” approach offers advanced climate analytics that can help countries and corporations manage their climate risk much more effectively. Similarly, our founding of the ‘Coalition for Climate Resilient Investment’, together with the World Economic Forum, aims to improve the pricing of climate risks and climate resilience in investment decision making.
Ultimately, addressing climate change is a responsibility we all share and it’s time for the BFSI sector in India to unite as the “WE” who can and must lead the way.