The Reserve Bank of India (RBI) has taken a remarkable and timely step towards addressing climate-related financial risks by introducing draft guidelines for regulated entities (REs) to disclose such risks. Presented last month, these guidelines aim to ensure that financial institutions are equipped to handle the challenges posed by climate change, which have the potential to impact their stability and resilience.
It is hardly a mystery that climate change has the potential to inflict a wide range of risks to financial institutions. These risks, whose frequency and intensity is only increasing over time — as manifested in a plethora of climate catastrophes — may not always be direct. The long-term shifts in climate patterns, rising sea levels, and environmental degradation can affect businesses, disrupt supply chains, and damage infrastructure. These physical risks not only strain an entity's cash flows but also jeopardise the value of collateral and assets. Furthermore, the transition to a low-carbon economy presents transitional risks, including policy changes, technological innovations, and shifts in public sentiment. Financial institutions may face credit risk as the value of assets depreciates, liquidity risk due to changes in consumer behaviour, and market risk from shifts in investor preferences and economic activity.
In response to these challenges, the RBI's draft guidelines propose a disclosure framework that covers four thematic pillars: governance, strategy, risk management, and metrics/targets. These pillars align with global standards set by the Task Force on Climate-related Financial Disclosures (TCFD) and aim to provide stakeholders with comprehensive information on an entity's approach to managing climate-related risks and opportunities. Under the framework, regulated entities are required to disclose their governance mechanisms for overseeing climate-related risks, including board oversight and risk assessment. They must also outline their strategies for addressing climate-related risks and opportunities over different time horizons and integrate climate risk into their financial planning processes. Risk management disclosures should detail how entities identify, assess, and monitor climate-related risks, as well as the extent to which these risks are integrated into their internal control frameworks. Additionally, entities must report metrics and targets related to greenhouse gas emissions and progress towards climate-related goals. The RBI’s disclosure framework envisages a phased response, with governance, strategy, and risk management pillars slated for disclosure by fiscal year 2025-26, followed by metrics and targets by fiscal year 2027-28. This phased approach allows entities to gradually adapt to the new requirements.
Implementing the disclosure framework will require significant changes to how financial institutions assess and manage risks. Effective management of environmental, social, and governance (ESG) risks during this transition necessitates inclusive risk assessment solutions, scenario analysis, and governance frameworks. While the RBI's draft guidelines represent a significant step towards addressing climate-related financial risks, effective implementation will require collaboration and commitment from all stakeholders. Financial institutions must invest in training, technology, and institutional frameworks to navigate the complexities of ESG risk management and ensure a smooth transition. To sum up, the RBI's proposal for a disclosure framework on climate-related financial risks is a proactive response to the growing threats posed by climate change. By promoting transparency, accountability, and risk management, these guidelines will help financial institutions build resilience and contribute to a more sustainable and stable financial system.