Banks across the globe are scampering and vying to set up a climate risk department. Is it just a fancy jargon for banks to publicize or there is more than what meets the eye? In the context of Indian Banking landscape, the awareness and preparedness towards the ‘Green Swan’ challenge are in its infancy.

The onslaught of the pandemic has been ruthless. Escalation in input costs, depreciating rupee, unemployment, inflation etc are few of the many economic evils that are beating down our economy. The browbeating of a “V” shaped recovery is only in print as many experts believe that there is instead a “K” shaped recovery, meaning only few sectors are upbeat while the majority of others are dragging their feet.

Of the few that have been able to tide over the Covid wave, Food and Agro, FMCG etc have been the front runners. For many banks it is a catch 22 situation as they behold the responsibility of engaging in ‘sustainable environmental finance’ or Green Finance while also contributing to the incessant exploitation of the environment. If banks were to toe the line, then funding opportunities for such companies shall dwindle thereby also depriving banks of staying in vogue. ‘May hay while the sun shines’ is the proverb that aptly describes the funding situation for banks at present.

‘What is in it for us bankers?’ is the question that begs to be answered with respect to sustainable environmental funding. Erratic and extreme climatic conditions along with the consequences they bring in can have a far reaching impact on a bank’s credit portfolio whilst in the long run. Credit risk has many manifestations and climate risk is one of them. Unbeknownst to the banks, the recalibration of risk assessment models, stress tests etc to quantify the losses arising out of climate risk is a far-fetched dream for many Indian Banks as of now. The default probabilities have to be more predictive as climate risk cannot, in no uncertain terms be looked at as a ‘one off event’ any longer. The longer banks take to realign and reimagine, the higher and sooner the likelihood of a systemic risk. 

The major challenges a bank is supposedly going to face are:- 

a) Which distribution to resort to?

b) What about the tail risk? 

c) Can one identify the symptoms before the shock event? 

d) Will the BAD Bank be able to purchase the bad loans arising out of climate impact? 

e) Will the banks have to write off AT1 bonds like in Yes bank case to survive the climate crisis given the permeability of its impact?

f)   Can the banks be insured against such risks? 

g)  Can banks purchase any tailored software/tools to capture such risks?

h) Should banks appoint 3rd party vendors to oversee climate risk? If yes, what is the scope provisioned for pertaining to Business Continuity and Cyber Risks?

The Regulator and banks are fraught with new vulnerabilities with respect to the above-mentioned set of apprehensions but the ghosts have to be slayed! 

 Banks for so long have looked at managing climate risk as a CSR activity and hence the wherewithal and imagination to now confront and address the lurking danger is lacking. However, the regulator and bank boards have a job on hand and that is to ask pin pointed questions and seek answers. Let us visit some of the purported questions.

1. Should we treat climate risk as reputational risk at worst? -The answer is a resounding NO. It is an offshoot of financial risk.

2. Do Banks need to integrate Climate Risk in their ERM charter? - Yes. Silo based Risk Management is passe. Risk appetite framework will have to be reworked alongside risk modelling requirements.

3. Should banks have a climate risk policy to fix the governance and roles- Yes along with precise VaR, sectoral, country and counterparty limits.

4. How can banks create a database for losses related to climate risk- There is always a first! Some data can be extracted from terminals installed by Bloomberg and Reuters and some based on internal risk climate and experiences. 

5. Should banks calculate capital requirements separately for climate risk? -Ideally Yes. This shall put forth a comprehensive picture and underwriting such risks shall become a tad easier.

While there are many opinions and views on climate risk and necessary measures to formalize the same, the stark reality is that the present situation can be best likened to ‘staring at a bottomless pit’. The Indian banks, especially the PSBs, have witnessed drastic changes and yet withstood the test of time right from the Global Financial Crisis ’08 to Digitalization and must I admit that they have done a commendable job. There shall certainly be a blueprint on climate risk in the foreseeable future but the need is to expeditiously build a strong risk and governance culture within banks so that employees at each level know their part in arresting a certain risk 

References: Green Swan Challenge and Climate Change Risk on member portal of Global Association of Risk Professionals (GARP), Climate change risk and bank sustainability -by Dr Arindam Bandhopadhyay, Climate Change- Managing a New Financial Risk-Oliver Wyman.

Disclaimer: The views expressed in this article solely belong to the author.