Disclosure Framework on Climate-related Financial Risks, 2024

General Studies Paper -3

Context: The Reserve Bank of India (RBI) has released a draft Disclosure Framework on Climate-related Financial Risks, 2024 for banks to follow.

About

• The regulated entities i.e., banks are meant to disclose information about their climate related financial risks and opportunities for the users of financial statements.
• It acknowledges the importance of the environment and its long-term impact on organisations and the economy as a whole.

What are Climate-related Financial Risks? 

• The RBI has defined climate-related financial risks as the potential risks that may arise from climate change or from efforts to mitigate climate change, their related impacts and economic and financial consequences.
• It can impact the financial sector through two broad channels i.e., physical risks and transition risks.
• Physical Risks: It refers to the economic costs and financial losses resulting from the increasing frequency and severity of extreme climate change-related weather events.
• Impact on REs: Expected cash flowsto the REs from an exposure may be stressed on the occurrence of a local / regional weather event.
  • Chronic flooding or landslides may present arisk to the value of the collateral that REs have taken as security against loans.
  • Severe weather events may damage a RE’s owned or leased physical propertyand data centers, thereby, affecting its ability to provide financial services to its customers.
• Transition Risks: It refers to the risks arising from the process of adjustment towards a low-carbon economy. 
  • A range of factors influences this adjustment, including changes in climate-related policies and regulations, the emergence of newer technologies, shifting sentiments and behaviour of customers.
  • The process of transition i.e., reducing carbon emissions may have a significant impact on the economy.

About the Framework:

• All India financial institutions, and top and upper layer NBFCs will have to begin to provide information ongovernance, strategy, and risk management strategy from 2025-26 and begin disclosure metrics and targets from 2027-28.
• Banks will be mandated to disclose those climate-related risks which have a bearing on their financial stability.
• The revelation will foster an early assessment of climate-related financial risks and opportunities and also facilitate market discipline.
• Organisations under the Purview:
  • All scheduled commercial banks (excluding local area banks, payments banks and regional rural banks).
  • All Tier -IV primary (urban) and cooperative banks (UCBs).
  • All top and upper layer non-banking financial companies.
• Disclosure by the REs: 
  • Identified climate-related risks and opportunities over short, medium and long term.
  • The impact of climate-related risks and opportunities on their businesses, strategy and financial planning.
  • The resilience of the RE’s strategy taking into consideration the different climate scenarios.

Significance

• There is an urgent need for a better and consistent disclosure framework for regulated entities, without which the financial risks can lead to mispricing of assets and misallocation of capital.
• This essentially led to a standard disclosure framework on climate related financial risks.