Expert Speak Terra Nova
Published on Jun 05, 2023 Updated 24 Days ago
The complex risks associated with climate change pose a threat to the global economy. Thus, it is crucial for regulators to proactively manage these risks to safeguard the stability of the financial system.
Climate twins: Weathering climate actions with fiscal stability As the world grapples with the consequences of climate change, it is important to recognise the need for climate change resilience with fiscal stability. To begin with, in India, the effects of climate change have already started to become visible, and the country has been taking steps to mitigate and adapt to them. India is one of the most vulnerable countries to climate change, with rising temperatures, changing precipitation patterns, and frequent extreme weather events. These impacts are leading to volatile agricultural productivity, increased water scarcity, and enhanced frequency and intensity of natural disasters such as floods and cyclones, and unseasonal rains across parts of the country. Without a doubt, such events pose a significant threat to financial stability. For example, unseasonal rains can cause extensive damage to one entire sowing season, leading to economic disruption, financial losses, and increased risk to the financial sector. The transition to a low-carbon economy might also create financial risks, as investments in fossil fuel-based industries may become a dead investment as the world moves towards renewable energy to achieve a more sustainable future. For example, a massive investment that was undertaken by the Indian Railways for the movement of coal traffic, 653 million tonnes in 2022, may be adversely impacted as the organisation shifts to renewable energy.
The transition to a low-carbon economy might also create financial risks, as investments in fossil fuel-based industries may become a dead investment as the world moves towards renewable energy to achieve a more sustainable future.
To address the challenges of climate change, the Indian government has taken several steps, including investing in renewable energy, increasing forest cover, and promoting sustainable agriculture practices. The government has also launched initiatives such as the National Action Plan on Climate Change (NAPCC) and the National Adaptation Fund for Climate Change (NAFCC). In the financial sector, to address imminent risks, the Indian government has been taking steps to promote financial stability in the face of climate change. The Reserve Bank of India (RBI) has, for instance, identified climate change as a key risk to financial stability and has taken steps to incorporate climate risk into its supervisory framework. The RBI has also launched a Green Strategic Policy Unit to promote green finance and has issued guidelines for banks to finance renewable energy projects. However, there is much more that needs to be done to ensure the country's resilience to the unfolding inevitability.Briefly, it is important to recognise that all climate change mitigation measures come at a cost. India has faced challenges in balancing the need for climate change resilience with the need for fiscal stability, and there are hypotheses that further investment in climate change adaptation and mitigation measures could disturb the country's fiscal deficit. To address this challenge, India must continue to prioritise climate action while also pursuing policies that promote economic growth and fiscal stability. This could include CAPEX measures such as increasing investment in clean energy and energy efficiency, improving the efficiency of the agricultural sector, and promoting sustainable tourism in a targeted manner. The government has also launched several initiatives to promote sustainable finance, including the National Clean Energy Fund and the National Adaptation Fund for Climate Change. The advocacy part can happen by upgrading the rigour of mandatory climate-related disclosures for financial institutions. These disclosures should cover not only the risks that climate change poses to them but also the opportunities that the transition to a low-carbon economy presents. This would also require institutions to disclose their carbon footprint, emissions reduction targets, and progress toward achieving these targets. Otherwise, green tagging will only be a risk by itself, with no impact on the ground. Furthermore, financial regulators need to increase the frequency of their stress-testing scenarios that incorporate climate-related risks. By doing so, they will assess the resilience of financial institutions to different climate change scenarios and identify potential vulnerabilities. Regulators can also encourage financial institutions to adopt sustainable finance principles and provide incentives to institutions that demonstrate a commitment to sustainability. As a listed markets regulator, the Securities and Exchange Board of India (SEBI) has recognised the need to address climate risks and mandates top-listed entities to annually file their sustainability reports.
Regulators can also encourage financial institutions to adopt sustainable finance principles and provide incentives to institutions that demonstrate a commitment to sustainability.
While there is still much more that needs to be done to promote financial stability in the face of climate change, the twin-pronged approach of India's financial sector to expand its priority towards climate risk management—including incorporating climate risk into credit risk assessments and investment decisions—with the government promoting sustainable finance by providing incentives for investments in green infrastructure, renewable energy, and other sustainable industries works best for the now.

Green challenges

Green finance—the financing of environmentally sustainable projects and activities—is a rapidly growing area of interest for financial regulators around the world. While there are many potential benefits to promoting green finance, there are also significant challenges and concerns that must be carefully considered. From the perspective of financial regulators, one of the primary concerns regarding green finance is the potential for greenwashing. Greenwashing refers to the practice of making false or misleading claims about the environmental benefits of financial products or services. Regulators must ensure that financial institutions are providing accurate and transparent information about the environmental impact of their investments and that they are not overstating the level of sustainability of their portfolios. This requires robust reporting and disclosure requirements, as well as strong enforcement mechanisms to ensure compliance. Another challenge for regulators is the potential for green investments to become stranded assets. Stranded assets are investments that become obsolete or lose value due to changes in technology or market conditions. Regulators must consider how to manage this risk, including through stress-testing of financial institutions' portfolios and the development of appropriate transition pathways. The best route is to ensure the adoption of company and board-driven plans to reduce annual carbon emissions with the target of becoming a net-zero emissions business say by 2050.
Regulators must ensure that financial institutions are appropriately managing these risks, including through the use of appropriate hedging strategies and risk management tools.
Regulators must also consider the potential for green investments to be subject to significant volatility and price fluctuations. This could occur due to a range of factors, including changes in government policy, technological innovation, and shifts in public opinion or consumer behaviour. Regulators must ensure that financial institutions are appropriately managing these risks, including through the use of appropriate hedging strategies and risk management tools. Finally, regulators must also consider the potential for green investments to exacerbate systemic risks to the financial system. For example, if there is a rush to invest in a particular type of green technology or infrastructure, this could create a bubble in that sector, leading to a potential collapse if the bubble bursts. Regulators must ensure that financial institutions are not taking on excessive risk in pursuit of green investments and that they are adequately diversified across a range of sectors and asset classes. The financial sector is a key player in the transition to a low-carbon economy, and financial regulators must work closely with industry stakeholders to promote sustainable finance practices. This involves developing frameworks and guidelines that encourage financial institutions to integrate climate-related risks into their decision-making processes and provide transparency on their exposure to these risks. As the world faces the pressing challenge of climate change, financial regulators have an essential role to play in ensuring financial stability and resilience. The risks associated with climate change are complex and interconnected, posing a significant threat to the global economy. Hence, it is crucial for regulators to proactively manage these risks to safeguard the stability of the financial system.
Dakshita Das is an expert on Infrastructure financing, Public Finance, and the Financial Sector and is currently heading a Government Committee on Gender Budgeting.
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Dakshita Das

Dakshita Das

Dakshita Das is a graduate from Lady Shriram College for Women New Delhi Dakshita Das joined the Civil Services in 1986. She has over 35 ...

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