The Treatment Of Physical Climate Risks By Central Banks

After enduring two years of record-breaking heat waves, India is at an “important juncture” in addressing physical risks, says this Climate Bonds Initiative-led report. The authors argue that while the Reserve Bank of India (RBI) has made significant strides in addressing climate-related financial risks in recent years, challenges persist.

To maintain its current momentum despite ongoing capacity limitations, the ODI researchers who authored the paper – Sherillyn Raga, Prashant Vaze, Elizabeth Tan and Archie Gilmour – advocate for a phased and proportional approach. Such an approach could include setting regulatory expectations and building capacity before introducing mandatory reporting standards.

RBI progress on climate-related physical risks

Since 2022, the RBI has engaged in various stakeholder consultations and surveys to assess sector readiness, although the results of these scoping exercises have been mixed.

While the RBI’s latest systemic risk survey found improved awareness of climate risks among regulated entities, earlier reports showed significant gaps in technical capacity and data availability. A striking 95% of regulated entities reported lacking necessary data for robust climate risk assessments in 2022.

In 2023, RBI governor Shaktikanta Das announced plans to publish guidance on green deposits, climate risk disclosure and scenario analysis. Since then, the bank has “launched several initiatives and has a pipeline of further regulatory activities” implementing this vision.

For instance, the RBI released a draft disclosure framework in February 2024. The standards reflect the structure of the International Sustainability Standards Board’s standards, include Scope 3 emissions reporting and adopt a tiered implementation approach.

While the authors consider the disclosure guidelines “ambitious in scope”, they say they lack the methodological standardisation necessary to produce comparable datasets across institutions.

Charting a future roadmap for India

Drawing on insights from interviews with officials at central banks across six countries, including Brazil, Malaysia and South Africa, the study reveals these challenges are not unique to India.

Many emerging markets are grappling with similar issues around data consistency and overall capacity.

The report proposes a four-phase roadmap for central banks in light of these challenges.

1. Awareness raising: identify climate change as a key risk, integrate this risk into mandates and evaluate capabilities.
2. Policy development: issue climate risk guidelines based on global best practices, perform top-down stress tests and work with regulated entities to refine policies.
3. Implementation: pilot climate scenario analyses and stress tests, then use the results to shape enhanced guidance.
4. Refinement and capacity building: incorporate climate risk into supervision with proportional compliance, providing targeted support and adapting policies to meet evolving needs and international standards.

The authors state that the RBI has already completed the first stage and they urge the bank to maintain momentum by “setting clear and ambitious timelines on the next policy steps”. In addition, the authors recommend engaging with regulated entities to build capacity and implementing mandatory requirements in line with the principle of proportionality.

The report also outlines several practical measures that have proven effective in other jurisdictions. These include: piloting stress testing exercises with volunteer banks; tailoring scenarios to nationally-relevant vulnerabilities; leveraging international standards and datasets; and institutionalising inter-agency collaboration for a harmonised approach.