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Mahesh

13/03/24 08:30 AM IST

RBI’s proposal for a disclosure framework to ascertain climate-related financial risks

In News
  • The Reserve Bank of India (RBI)  presented draft guidelines on Disclosure framework on Climate-related Financial Risks, 2024.
Physical risks
  • Physical risks refer to economic costs and financial losses as a consequence of the increasing frequency and severity of extreme weather events (like heatwaves, landslides, storms and wildfires), long-term gradual shifts in climate (such as extreme weather variability, rising sea levels and ocean acidification, among others) and indirect effects (like degradation of soil quality or marine ecology, among others).
  • The impact may vary subject to geographical locations.
  • Although, any exposure to such risks may stress an entity’s cash flows, the primary risk emerges out of a potential disruption of a corporate value chain or lower economic or sectoral activity.
  • Further, events such as chronic flooding or landslides may risk the value of a collateral (especially immovable property) taken as security against loans.
  • Severe weather events could also damage banking entity’s properties or data centre assets, impacting their ability to provide services to customers.
Transitional risks
  • This could manifest in a potential downgrade in credit ratings or financial valuation because of a climate mitigation policy or introduction of incentives encouraging the use of energy efficient means.
  • It may entail increased costs or an overhaul of operations. Technological innovations (towards clean energy) could depreciate the value of (existing) assets dependent on older technologies, leading to a reduction in the cash flow of certain borrowers.
  • Shifts in public sentiment also have a role to play.
  • This refers to an increased preference for savings, projects and/or investment instruments with more climate-friendly policies and fostering a positive impact on the environment.
Other risks involved
  • Climate change can spur a demand for liquidity. This can be in response to extreme weather events or consumers perceiving future difficulties in liquidating their assets if a climate event has a negative impact.
  • This may in turn impact an entity’s capacity to raise funds and address obligations. Banks also stand the risk of not meeting their exposure to claims (say, against insurance products) from customers who are seeking to recover their climate-related losses.
  • This could be particularly acute if there is a heavy concentration of a vulnerable sector in their portfolio.
  • Lastly, markets risks may emerge should there be a shift in investor preferences or climate induced adverse effects on underlying economic activity.
Control measures
  • RBI has acknowledged the uncertainties surrounding the timing and severity of climate-related risks.
  • These threaten the “safety, soundness and resilience” of individual entities, and in turn, the stability of the overall financial system.
  • Conventional backward-looking risk assessment methods are unlikely to adequately capture future impacts.
  • RBI has observed that future impact would be determined by actions taken today, especially when greenhouse gas emissions above a certain threshold have irreversible consequences.
  • For financial institutions, adequate information on this front would help avert the possibility of mispricing assets and misallocation of capital by banks.
  • The draft framework proposes disclosures be made on four parameters: governance, strategy, risk management and metrices and targets.
  • The basis of risk management is to communicate processes and policies to “identify, assess, prioritise and monitor” climate related risks, processes to manage them and the extent to which they are integrated into an entity’s internal control framework.
  • In other words, they must disclose how the nature, likelihood and magnitude of the effects of climate-related financial risks are ascertained.
Source- The Hindu

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