Climate-related financial risk: RBI to release guidance notes on scenario analysis, stress testing
The Reserve Bank of India (RBI) is planning to release guidance notes on scenario analysis, stress testing, and effective management of climate-related financial risks, said Deputy Governor M Rajeshwar Rao.
The guidance notes will be based on the Basel Committee on Banking Supervision (BCBS) principles
“Proposals for tackling climate change and containing global temperature sometimes give rise to contradictory views as pro-climate actions are perceived to compromise on economic growth and employment.
“However, there is an immediate need to act in a calibrated manner. We cannot afford to procrastinate,” Rao said at a recent JP Morgan India Leadership Series Lecture.
The Deputy Governor emphasised that rising temperatures and climate events were already inflicting huge financial costs and causing irreparable damage to the ecosystem.
“If we start early, the cost of transitioning to a more sustainable future would be lower and spread out over a longer time horizon,” he said.
Therefore, early work on mitigating climate risk would support long-term growth. The investments in climate action would pay-off in the medium and long-term.
“The important point here is that the short-term impacts should not be disproportionate to some countries, in the sense that they should not be worse off during the transition process,” Rao said.
Therefore, there is a need to channelise climate finance to EMDEs (emerging market and developing economies) and firm and abiding commitments on climate funds from advanced economies to help EMDEs in the transition process is very important.
Managing climate risk
Rao said adaptation and transition are key strategies in managing climate risk. However, the transition must be swift, equitable and just, without putting undue burden on developing and underdeveloped economies.
“We also need to address the elephant in the room, which is how to finance the transition towards a low-carbon economy.
“Given the significant funding gaps and huge financing requirements of EMDEs (estimates range from 2.5 per cent of GDP annually in case of India and at $2 trillion per year by 2030 for EMDEs) access to transition finance is important,” he said.
Transition plans
Rao observed that transition plans are essential for banks and financial institutions to mobilise capital and manage financial risks that may arise from climate-related financial risks.
The transition plans must be strategic and top-driven, while having explicit components for geographical regions as also for industry and entity levels, he added.
“While transitioning is crucial, we cannot overlook the immediate impacts of climate events. There is, therefore, a need to look at the adaptation part, which is a missing link as far as evolving climate strategies are concerned,” the Deputy-Governor said.
Adaptation involves responding to climate event impacts, which steadily deteriorate the environmental conditions essential for daily living, such as access to water, energy, air quality, and tolerable working temperatures.
These conditions can be disrupted by short-term shocks such as storms, floods, and wildfires, which have abrupt and devastating effects.
“Establishing early warning systems and disaster preparedness plans is crucial for minimising loss and damage and, therefore, adaptation financing is critical for building economic resilience and fostering sustainable development.
“One way to do that is by integrating adaptation financing into resilience and disaster management frameworks,” Rao said.