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Financial institutions must recognise the climate risks

Banks need to internalise climate risks as a part of their risk assessment, pricing and decision making. The objective is not to make financial institutions more risk averse, but rather to provide a means to climate-proof the financial sector and ensure sustainable growth

analysis Updated: Sep 26, 2018 15:48 IST
Vidya Soundarajan and Cristina Rumbaitis del Rio
Vidya Soundarajan and Cristina Rumbaitis del Rio
Environmental activists gather to urge world leaders to take action against climate change in Bogota, Colombia, September 8(REUTERS)

The value of global financial assets at risk from climate change is estimated at $2.5 trillion, whereas the Economist Intelligence Unit estimate is closer to $4.2 trillion,” says a report in The Guardian. As an immediate example closer home, Kerala is assessed to have incurred losses of over $1.6 billion due to floods in August. The loss to crops, life, livelihoods, health and socio-economic impact of the ravaging, disastrous flood has not even been estimated yet. This damage would take the people of Kerala, the government, the private and the financial sector at least a decade to recover.

Climate change is emerging as a serious threat to India’s financial health and economic development. The Economic Survey 2016-17 estimates that India incurs losses of approximately Rs 7,000 crore annually due to extreme weather events such as floods, droughts, rising peak temperatures, and water shortages. This loss is around 0.38% of India’s GDP of $2,597 billion (2018) and may not seem alarming, but the increase in intensity and the frequency of the climate induced disasters makes this is a growing problem that needs to be addressed.

The probability of such extreme disasters is rising rapidly from one in 100-year events earlier, to one in every 10 years now for many cities. If these continue to occur, the extent of economic losses could multiply from what we have seen to date in places like Chennai and Kerala. We know that costs from catastrophic weather events are rising, not just in monetary terms, but many times more when seen in terms of loss of lives, and livelihoods, savings, capital assets, and jobs and incomes of the rural poor on a much more routine and regular basis. That’s a social catastrophe (even if not yet in economic terms) of major consequence that is already happening.

Fifty-two per cent of India’s population depends on agriculture and their concentration is even higher at 76% in the villages. Rise in temperature has a direct impact on the Rabi crop and every 1 degree C rise will reduce wheat production by four to five million tonnes. It is predicted that a loss of 10 to 40% in production may occur by 2100 due to climate change. Urban areas and associated infrastructure is not immune to these stressors either. These climate-induced events disrupt business operations directly through physical damage to infrastructure, and indirectly by additional market risks. Managing and mitigating climate risks will require private sector and government to work together to devise innovative solutions. While the government has the biggest role to play in building resilience, private sector and financial sector need to not only act on climate change to cut their losses but also to help the government deliver better and faster. The window of opportunity to act is finite.

The overall risks are rising to the financial sector. The impacts are now growing beyond the micro-enterprise and rural lending to formal sector banking and insurance companies. The industry is beginning to acknowledge these risks and needs discrete frameworks and tools to guide their decision making. Consensus on key parameters to map climate risks and categorise losses incurred due to climate change is yet to emerge. The standard disclosure from financial institutions does not lend itself to better policy recommendations and decision making on this issue. This is largely owing to the limited understanding of direct and indirect financial effects of this climate induced disasters. This move towards increased internalisation of climate change parameters is not to make financial institutions additionally risk averse, but to provide a strong rationale for a more climate-informed lending protocol. This must be ably complemented by extensive risk insurance, public disaster management funding and additional capabilities in budget, and city planning. The way forward for financial institutions is to recognise the risks of climate change and hence change the climate of India’s financial sector.

(Due to a technical glitch, 1 degree C was printed as 10 in the fourth paragraph of the print edition. We regret the error)

Vidya Soundarajan, India Regional Programme Manager, Action on Climate Today

Cristina Rumbaitis del Rio, Regional Programme Manager, Action on Climate Today

The views expressed are personal

First Published: Sep 26, 2018 12:34 IST