The Reserve Bank of India (RBI), in its Utkarsh 2019 vision statement, for the first time clearly articulated its position in respect of climate change. RBI stated one of its objectives in the medium run as – “[a]assessment of risk and compliance culture and business strategy of SCBs to strengthen the health of the financial system, with special attention to the unique risks posed by climate change and implications for the supervisory framework” (Utkarsh) [Para VI.53 - VI.54].
Since then, RBI has not refrained from underscoring this issue in various publications. A recent financial stability report states that – “an important factor that is set to reshape the macroeconomic and financial landscape is the impact of climate change and the mitigating policy commitments at the Conference of the Parties – 26th United Nations Climate Change Conference (COP-26)”.
RBI has also formed a sustainable finance group within the department of regulation to spearhead the efforts in respect of climate risk and a discussion paper on ‘Climate Risk and Sustainable Finance’ was placed on its website for wider stakeholder consultation.
As the current situation stands, banks in India have already instituted environmental, social, and corporate governance (ESG) policies and green bond frameworks and have committed resources to finance green projects such as renewables.
Banks are also adhering to national guidelines on the economic, social and environmental responsibilities of business and Indian Banks’ Association (IBA’s) national voluntary guidelines for responsible financing.
However, as the RBI survey reveals, there is considerable divergence in respect of understanding and accommodating climate risk within business decisions among regulated entities.
Gaps in the current state of understanding, in part, are dictated by history because commitments under the Kyoto Protocol were not binding on India, and partly because climate debate was essentially within the field of climatology, earth sciences, disaster management and, in the Indian case, foreign policy which banks seldom deal with.
Then, the response of banks to the climate debate in the US and in Europe has a somewhat different history. In the US, mounting pressure on banks through class action suits created awareness among US banks to account for this risk.
In Europe, it was public pressure that many European banks finance projects that were environmentally damaging and created climate awareness. None of such factors was at play in India but they may become significant in the coming years.
The earliest computable general equilibrium models developed for India, to assess the impact of climate change, clubbed banks under the broader services sector. This diluted the critical role played by banks in channelising financial resources.
As a result, even though the core climate debate in India is roughly two decades old, the role of banks and financial institutions has become prominent only recently.
RBI has posed six broad questions in its discussion paper. However, the focus here is on a very narrow but central problem which has been highlighted in the discussion paper pertaining to the carbon footprint/ intensity of banks and the banking sector in general.
The ministry of environment, forest, and climate change, since 2015, has been regularly publishing the biennial update report (BUR) to the United Nations framework convention on climate change which gives official estimates of the national greenhouse gas inventory of anthropogenic emissions by sources and removals by sinks. The same can be used, with some assumptions and applying the technique of lifecycle analysis, to calculate the carbon footprint of the financial sector.
Keeping the technicalities aside, the imputed direct anthropogenic emission for the financial sector (comprising banking & finance and insurance) derived for the years 2010, 2014 and 2016 is presented in the graph below.
The share of direct emissions from the financial sector is of the order of 0.1% of total emissions for each of the three years. The largest component of the direct emission is from fuel combustion followed by waste, as per the classification used in BUR.
It is worth observing that emissions increased by a factor of 3.4 between 2010 and 2014 and by a factor of 2.7 between 2014 and 2016. Since emissions are directly proportional to the output produced, this steep rise can be traced to the expansion of banking operations between the years 2010-2016, on account of the thrust toward financial inclusion which attained a peak with JanDhan.
This expansion in the banking network is attributed to private banks that added more branches relative to public sector banks (PSBs) in two sub-periods. The total functioning offices of commercial banks increased by a factor of 1.38 (PSB - 1.36 and private banks - 1.76) between March 2010 to March 2014. The ratio for the second sub-period was 1.14 (PSB - 1.11 and private banks - 1.36).
The carbon intensity of any sector is not just direct emission but also indirect emissions. In the terminology of the greenhouse gas (GHG) protocol, these are Scope 1, 2 and 3 emissions. In the case of banks, Scope 3 constitutes the loans extended to various sectors.
The period March 2016 to March 2017 is rather special when emissions witnessed some decline. For the years ending March 2016, credit was generally sluggish, reflecting lacklustre demand in the economy, asset quality concerns, the ongoing deleveraging through write-offs and some amount of disintermediation in favour of relatively cheaper source of funds outside the banking system, as noted by RBI in its Annual Report 2016.
In the subsequent year, RBI’s annual report notes that banks engaged in diversifying their credit portfolios, reducing their exposure to large industries and shifting towards the relatively less stressed categories of housing, personal loans and services. One-off factors like demonetisation and the redemption of foreign currency non-resident (bank) deposits impacted the behaviour of monetary aggregates during the year. Lastly, final guidelines on the large exposures framework and enhancing credit supply for large borrowers through market mechanisms were also issued in order to diversify the lending base of banks.
The essential picture is, in 2016, Scope 3 emissions were reduced because of easy loan availability outside, the move toward market borrowings under a large corporate framework, demonetisation and subsequent halving in the GVA growth rate of the financial sector to 3.5% in FY16-17.
In conclusion, this study has been a revealing exercise as it gives a historical context to the climate debate, in respect of the carbon footprint of the financial sector. Since banks dominate the finance sector, the observed trends will be highly correlated with trends in pure banking. The study somewhat exceeds the scope of the RBI discussion paper as it also covers the entities not regulated by RBI. But, with many banks having an interest in insurance by way of subsidiaries, these findings give a bird’s eye view of the carbon footprint of the sector in general.
(The author is an economist in the banking system. The views expressed here are personal)