Climate Finance: The role of financial institutions in mitigating climate risks

Muskaan Kapoor, Engagement Officer, CDP India
Pratik Sanadhya, Manager, CDP India

Are financial institutions (FIs) really the front runners in the Environment, Social, and Governance (ESG) race or the true scene behind the fog is a different story? Over the past few years, ESG has successfully gained momentum and witnessed a paradigm shift in which, the IT industry and FIs are considered the best-performing sectors of all.

According to the IPCC, India is among the most vulnerable countries to climate change, with exposure to rising sea levels and changing monsoon patterns which have already led to a loss of 16 per cent of its per capita GDP since 1991. Many think tanks, organizations, and even the World Bank predicts climate change to hit India’s annual GDP by 2.8 to 3 per cent by 2050. More dire projections are being made by other studies. It has also been observed that sadly not a single Indian banking entity is a member of the UN-convened Net-Zero Banking Alliance which lists banks from 40 countries as members. Several FIs too have ascertained that India’s GDP will suffer tremendously because of climate change.

It is evident that climate change is a hard-core economic issue and the impact of the climate crisis on the Indian economy will be far-reaching. Even in the rosiest of scenarios, no sector in the Indian economy would be immune from the devastating consequences of the forthcoming climate catastrophes if sufficient steps aren’t taken toward its mitigation soon.

As such impacts of climate change keep unfolding, the financial sector will be at the core of the reactor and the responsibility to provide stability would lie in the hands of banks, and asset managers. Is the banking sector sufficiently prepared to undergo such transformations? Will the banking sector be able to provide sufficient support to the manufacturing, transportation, and agricultural sector, or would it just be a bystander? Have banks begun to realize the urgent need to align their operations and portfolios with the nation’s 2070 goal of becoming a net-zero carbon emitter?

Indian companies in the financial sector are at a shocking approximately Rs 1,145 billion climate-related financial risk as reported through CDP (formerly Carbon Disclosure Project). The predominantly accountable aspect stands Banking Portfolio with approximately Rs 900 billion under the Acute Physical risk category. For financial institutions, the indirect emissions caused by financing activities across their banking portfolios are significantly relevant and without accounting for these emissions, the above risk can’t be addressed. The emissions have been classified by the GHG Protocol in Scope 3 Category 15 – Investments. Taking the example of climate-related financial disclosure, all surveyed foreign banks are adhering to climate-related financial disclosure that too with the recommendations of the TCFD framework, which is supported by 110 financial regulators, including 50 central banks. This provides several learnings for Indian banks.

Now, as per the latest CDP disclosures of 2022, even though 11 Indian financial services companies had filled out CDP questionnaires, only 1 firm considered disclosing its emissions incurred due to Category 15 – Investments in its Scope 3 emissions inventory. Financial institutions need to have long-term targets in place for emissions across all scopes, as it is important to have reductions at all levels of emissions. It is well known that the Science-Based Targets initiative is the gold standard for setting climate change targets. In India, only two financial institutions have, thus, far committed to set near-term targets, but none have gotten their targets officially validated. It is, hence, noteworthy that none of the banks have set long-term net-zero targets with an implementation plan covering scope 1, 2, and 3 emissions.

This distinctly instigates a state of poor awareness and unpreparedness in the financial services sector in the Indian context giving rise to alarmingly high financial impacts associated with climate-related risks. Engaging banks intensively is vital for shifting capital at the pace and scale required, as well as working together with their clients in the real economy.

In order to achieve a state of the net-zero economy by 2050, firms in the financial services sector better start reviewing more than the emissions generated by their own business activities. This implies that financial institutions must measure and report the emissions generated by the companies they invest in and lend to thereby greening their banking portfolios.

To conclude, the single most important step that financial institutes can take is to have transparency and public disclosures. They should not only be focused on profit but also on the planet and the people. They should develop robust systems and methodologies to calculate granular Scope 3 emissions including investment (portfolio) emissions in their financial disclosures.  The financial sector is a major climate change and risk-impacted sector thus risk management frameworks must be devised to reduce the financial implications of climate change-induced risks.