Indian banks’ unbridled lending to carbon-intensive sectors is facing investor scrutiny amid fears of rising transition risks
Banks in India have begun to reassess loans to carbon-intensive sectors amid growing pressure from international investors to mitigate against transition risks and adhere to global environmental, social and governance standards.
According to Statista, India is the world’s third-largest polluter after China and the US. Its goal is to reach net zero by 2070, but local regulations on ESG disclosures are still in their early stages, with a mandatory disclosure regime for banks currently only in the consultation phase.
“We recognise that global investors have an ESG checklist that they need to tick off in terms of commitments to sustainability in their investee companies, and we have a responsibility to those investors,” says Rajiv Anand, deputy managing director at Axis Bank.
The Reserve Bank of India, the country’s central bank, announced in May 2023 that it plans to formulate guidelines around disclosure requirements pertaining to climate-related risks of banks. Further guidelines will be released mandating financial institutions to incorporate environmental risk factors in their risk management process.
Despite the growing domestic momentum, Indian banks are still facing pressure from abroad to examine their transition risks.
“More than 50 per cent of our investor base is global,” says Anand. “Therefore, banks – especially private banks in India – don’t have the luxury of hiding behind what, in some cases, may be perceived to be relatively less stringent norms in the Indian context.”
Growing threat of transition risks
According to Moody’s, an estimated 25 to 35 per cent of loans in India’s banking system are directly exposed to carbon-intensive sectors that have high risks associated with the transition to low-carbon economic models. These include loans to corporate clients operating in coal-fired power generation, coal mining, oil and gas, and diesel-intensive transportation and logistics.
In addition, about 12 per cent of loans are directly exposed to the agriculture sector, which is at risk from extreme weather events such as droughts, floods and cyclones.
“The number one reason banks are looking into their carbon-intensive loans is transition risks,” says Amit Pandey, vice-president at Moody’s Investors Service. “If a bank has a 25-year loan to a certain company, will that company be obsolete because of the climate transition in 10 years? Those are the kinds of questions counterparties are asking, which drive banks to look at these issues more seriously.”
In addition to a large proportion of loans to carbon-intensive sectors sitting on their balance sheet, the goal of achieving carbon neutrality has yet to become a priority for Indian banks. According to a report by Climate Risk Horizons, only 10 out of 34 Indian banks have started disclosing Scope 1 and 2 emissions as of 2023. Eight of these have started disclosing some Scope 3 emissions as well.
In addition, no Indian bank is a member of the Net-Zero Banking Alliance, part of the Glasgow Financial Alliance for Net Zero, which is seeking to accumulate a critical mass of commitments from the global financial industry to achieve the target of net zero carbon emissions.
“Indian banks also face the risk of reputational damage,” says Pandey. “If you look abroad, there are many groups that rank how banks are doing in terms of the green transition.”
Regulatory momentum
While the greatest pressure to address the net zero transition for Indian banks still comes from global investors, local regulators are starting to recognise the importance of the green economy to remain competitive.
“Indian regulators are taking measures to incentivise market players to transition towards sustainable practice to address [India’s] own ecology and environment, and to make sure that the country remains an attractive destination for foreign investors,” says Kamran Khan, head of ESG for Asia-Pacific at Deutsche Bank.
Adding to its push for sustainable financing, the RBI announced the regulatory framework for “green deposits” earlier this year. The framework, which came into force from June 1, 2023, ensures that regulated entities put in place a board-approved financing framework for the effective allocation of green deposits.
The central bank also plans to release guidelines on a green asset ratio, which will set a minimum threshold level for the proportion of total assets invested in sustainable projects for financial institutions to maintain.
“If India remains idle on sustainability, its economy and financial markets would struggle to attract the kind of overseas capital that they are hoping for,” says Deutsche Bank’s Khan.
This article first appeared in The Banker