Climate Risks Call For Green Financial System

Context: The financial system is exposed to systemic risks from extreme climate events requiring central banks to be prepared. India will soon need to start making public its position on climate-related financial risks.

Issues with Climate risks to financial investments:

• Climate risks are uncertain and irreversible: With increasing frequency and severity, climate disasters have the potential to rupture economic activity, financial system, monetary policy, price stability, inflation and interest rates.
• Greenwashing: Despite the recognition of climate risks and rising temperature, stakeholder response in past decades has been dominated by ‘green-washing’, generating public distrust.
• The word ‘greenwash’ entered the dictionary in the 20th century. It means disinformation dissemination to present an environmentally responsible public image.
• Lacks regulatory backing: Despite rapid growth in green bond issuance volume, the market remains in its infancy lacking certification, use of proceeds and disclosure parameters. 
• Asset values lack climate risks: A recent IMF study highlighted that climate change physical risk does not appear to be reflected in global equity valuations.

Steps taken to check climate-related financial risks:

• Network for Greening the Financial System (NGFS): This consensus-driven forum has the mandate to share best practices to foster a greener financial system.
• ESG (environmental, social and corporate governance) evaluation initiative: Launched by rating agencies value to the rapidly rising demand to apply ESG lens to investing. 
• Private sector involvement: India’s large conglomerate Reliance recently gave a timeline to go net carbon-neutral by 2035, much earlier than BP Shell’s timeline of 2050.

Way Forward:

• Climate-smart investments: 

• Investors need to be equipped with tools, instruments and products for making climate-smart investments.
• Supervisors need to promote investor awareness, research into climate-safe investments, listing of green bonds and facilitate retail green deposits.
• Developing a rating system: Switzerland-based Bank for International Settlements (BIS) has advocated a case for developing a rating system linked to carbon intensity at the firm level.
• Climate sensitisation: Company boards could become climate-savvy by sensitising themselves on climate governance to fulfil their oversight and directional role.
• Blending financial safety of reserves with safety from climate risks: Central banks now need to invest in climate-resilient AAA reserves that provide the highest degree of safety and are liquid.
• Quality disclosures: Central banks are examining equating or giving climate-related data the same status as accounting disclosure. There is also a move to consider pricing carbon risk in the context of syndicated bank loans.
• Green monetary policy: Monetary policy affects stakeholder behaviour and economic activity. It now needs to reflect a green footprint away from fossil fuels.