Only four of the ten major financial institutions surveyed collect information on Environmental, Social and Governance (ESG) risks. Moreover, these firms do not systematically use that information to make financial decisions
India's financial sector is highly exposed to the risks of a low carbon transition, but only one in six finance professionals have the experience in identifying and managing those risks according to a new paper titled “Low carbon- transition risks for India’s financial system.”
In the year 2021, Prime Minister Modi committed India to reach net zero emissions by the year 2070. The shift to a zero carbon economy will reduce the impacts of climate change, but undermine the profitability of polluting firms and create stranded assets.
Only four of the ten major financial institutions surveyed collect information on Environmental, Social and Governance (ESG) risks. Moreover, these firms do not systematically use that information to make financial decisions.
Further, high carbon industries like power generation, chemicals, iron and steel, and aviation account for 10 per cent of outstanding debt to Indian financial institutions. These industries are also heavily indebted, and therefore have less financial capacity to respond to shocks and stresses.
"India's financial sector is still nascent when it comes to assessing the physical and transition risks of climate change. Our survey of over 150 finance professionals across 10 of India's largest banks reveal that just one in six have the expertise or experience to apply ESG (environmental, social and governance) risk assessments in credit decision making. There is therefore an urgent need for financial institutions to build systems to integrate climate risk into financial decisions and enhance knowledge of credit & risk officers, to better respond to the climate emergency," elaborates Namita Vikas, Founder and Managing Director, auctusESG.
Coal currently accounts for 44 per cent of India’s primary energy and 70 per cent of its power generation. The country’s coal-fired power plants have an average age of 13 years and India has 91GW of new proposed coal capacity in the works, second only to China. According to the Draft National Electricity Plan 2022, coal’s share in the electricity generation mix decreases to 50 per cent by 2030 compared to the current contribution of 70 per cent.
Achieving India’s climate targets demands that many of the planned coal plants are not built. Achieving an energy system consistent with 1.5°C requires that unabated coal plants are all retired by 2040, even if they are still technically viable. Yet, the new analysis finds that only around one-sixth of lending to the electricity sector is to pureplay renewables.
“The financial decisions of Indian banks and institutional investors are locking the country into a more polluting, more expensive energy supply. For example, we find that only 17.5% of lending to the power sector has been to pureplay renewables. Consequently, India has much higher-carbon electricity than the world average, despite its vast potential for cheap solar, wind and small hydropower. Shifting resources towards these renewables would deliver huge benefits: cheaper electricity, cleaner air and fewer emissions ” said Sarah Colenbrander, Director, Climate and Sustainability, ODI.
The Study comes at a time when India is launching its first ever sovereign green bonds auction. The Reserve Bank of India (RBI) will auction 5 year and 10 year green bonds worth 40 billion rupees each on January 25th and on February 9th, 2023. India has also recently assumed the presidency of the G20 Summit on the first of December, which will have some focus on the energy transition and mobilising sustainable finance.
Mapping India’s policy commitments against these lending and investment patterns reveals that India’s financial sector is heavily exposed to potential transition risks. “The Reserve Bank of India has recognised the transition risks exposure to the Indian banking sector and set the direction for regulated entities on integrating climate risks in their stress tests and disclosures through its July 2022 discussion paper. Financial institutions will need to ramp up their capacities relatively quickly as the RBI led momentum further picks up. The other side of risks is the tremendous opportunity to move finance towards sustainable assets and activities. Robust, internationally interoperable taxonomies play a huge role in guiding finance credibly. The Ministry of Finance’s draft taxonomy developed in 2021 is awaiting its release. It would add a great boost to realise the huge potential for green finance in India” adds Neha Kumar, Head, South Asia Programmes, Climate Bonds Initiative.
The study also takes a look at the value of outstanding corporate bonds in sectors facing high transition risks. These sectors are home to many of the blue-chip companies that dominate India’s debt markets and thus account for a large share of outstanding Indian corporate bond issuance: INR 4.4 trillion as of 2021 out of INR 40.2 trillion as of 2022. The largest issuer of corporate bonds by sector among the carbon-intensive sectors is oil, gas and consumable fuels, with outstanding bonds worth INR 1.9 trillion (USD 25.9 billion) as of June 2021. Electric utilities account for a further INR 1.2 trillion (USD 15.4 billion).
40.8 per cent of the bonds issued by oil, gas and consumable fuels are denominated in foreign currencies, which are more likely to be held by foreign investors. However, 90.5 per cent of the bonds issued by electric utilities are denominated in the Indian rupee. These results imply that the portfolios of domestic financial institutions are significantly exposed to transition risks given the large share of domestic currency corporate bonds issued by the power sector and that four-fifths of lending to this sector flows to utilities that generate power substantially or even exclusively from fossil fuels.
As the low-carbon transition accelerates, firms and sectors are at risk of not generating the anticipated returns, with implications for both individual financial institutions and financial markets.