Inclusion of climate change in policy is crucial for a strong economy

Source: The post is based on the article “Inclusion of climate change in policy is crucial for a strong economy” published in the Indian Express on 27^th August 2022.

Syllabus: GS 3 Indian Economy; Ecology and Environment

Relevance: Monetary Policies dealing with the climate change issues

News: In July 2022, the Reserve bank of India (RBI) released a discussion paper that covers the issue of climate risks and sustainable finance.

About the RBI recent discussion paper

The RBI’s earlier research papers or report could not address the comprehensive risk assessment.

Therefore, this paper seeks to understand preferred approaches to identification and disclosure of exposures to climate-related risks, transition risks, frameworks for management of risks and capacity building within the banking sector etc.

The RBI wants to assess the preparedness of the system rather than indicate its own approach to what a central bank can do.

What is the importance of the RBI’s recent consultation paper?

It shows the Reserve Bank’s inclination to address emerging risks from climate change and a full assessment of macro-risks that may arise from disinvestment from fossil fuel-based assets.

Further, the discussion paper also indicates the RBI’s understanding of the requirements of the regulatory changes.

The paper allows the RBI to respond based on existing practices and a better understanding of the risk profiles of banks.

What are the issues in the discussion paper?

The scope of discussion in the paper remains limited and without a general narrative on the central bank’s role.

It does not detail the various instruments such as capital requirements for fossil fuel-based lending by banks or credit guidance that can be worked by a central bank to ensure the greening of the financial system.

Why should the central banks acknowledge the climate change risks?

(1) Exposure of assets to extreme weather events and loss of asset value due to a green transition are imminent risks to the financial system.

(2) Inclusion of climate change in a central bank’s policy response remains unaddressed. Climate change is a significant threat to financial stability and the central banks are “failing to do its job” to address climate risk.

(3) Central banks can guide the flow of finance by restricting the flow of credit to fossil fuel-dependent sectors.

What are various measures related to the acknowledgement of climate change risks?

Globally

(1) Some Central Banks have adopted a range of best practices and approaches. For example, (a) the Bank of Lebanon sets different reserve requirements for loans linked to energy savings, and (b) the People’s Bank of China offers positive incentives to commercial banks for extending green credit,

India

(1) The Reserve Bank of India has included renewable energy (RE) within priority sector lending.

(2) In 2021, the RBI joined the Network for Greening Financial System which promotes the exchange of best practices on green finance across the world.

(3) In 2021, RBI issued research papers indicating a growing acknowledgement of risks to the financial system. The RBI has acknowledged that extreme weather events can elevate inflation.

(4) In 2022, RBI estimated the direct and indirect exposure of Indian banks to green transition in India.

What should be done?

While the RBI, disclosures and risk assessment frameworks are a starting point. It remains to be seen what macro and micro-prudential regulations will be introduced by the Reserve Bank of India (RBI).