Climate-Risk Assessments in Banking

Climate-risk assessments in banking refer to structured processes through which banks and financial institutions identify, measure, and manage risks arising from climate change and the transition to a low-carbon economy. These assessments have become an integral part of modern financial risk management as climate change increasingly influences economic activity, asset values, and financial stability. In the Indian context, climate-risk assessments are particularly significant due to the economy’s high exposure to climate hazards, dependence on climate-sensitive sectors, and the central role of banks in financing growth and development.

Concept and Scope of Climate-Risk Assessments

Climate-risk assessments evaluate how climate-related factors can translate into financial risks for banks. Unlike traditional risk assessments that focus on historical data and short-term horizons, climate-risk assessments adopt a forward-looking perspective and consider long-term uncertainties. They encompass both direct and indirect impacts of climate change on borrowers, assets, and financial markets.
The scope of climate-risk assessments extends across multiple risk categories, including credit risk, market risk, operational risk, liquidity risk, and reputational risk. By embedding climate considerations into these risk dimensions, banks gain a more comprehensive understanding of vulnerabilities that may not be captured through conventional assessment frameworks.

Types of Climate Risks Considered in Banking

Climate-risk assessments in banking typically focus on three interrelated categories of risk. Physical risks arise from acute climate events such as floods, cyclones, heatwaves, and droughts, as well as chronic changes like rising temperatures and altered rainfall patterns. These risks can damage assets, disrupt supply chains, and reduce borrower repayment capacity.
Transition risks emerge from policy measures, regulatory changes, technological advancements, and shifts in market preferences associated with the transition to a low-carbon economy. For banks, transition risks may lead to declining asset values, stranded assets, and changes in the creditworthiness of carbon-intensive borrowers.
Liability risks relate to potential legal claims and compliance costs arising from inadequate climate risk management, misrepresentation, or failure to meet evolving disclosure standards. While liability risks are still developing in India, their relevance is expected to grow over time.

Climate-Risk Assessments in the Banking Sector

In practice, banks conduct climate-risk assessments by analysing sectoral and geographic exposure of their loan and investment portfolios. Sectors such as agriculture, power generation, infrastructure, transport, real estate, and manufacturing are closely examined due to their sensitivity to climate conditions and policy transitions.
Banks also assess the vulnerability of collateral to physical climate risks, particularly in flood-prone or coastal regions. Climate-risk assessments increasingly involve scenario analysis to evaluate how different climate pathways could affect borrower performance and asset values over medium- to long-term horizons.
These assessments support more informed credit appraisal, risk-based pricing, and portfolio diversification. They also strengthen internal governance by integrating climate risks into risk appetite statements, board oversight, and strategic planning processes.

Relevance to the Indian Economy

India is among the most climate-exposed economies globally, with frequent climate-related disasters affecting agriculture, infrastructure, and livelihoods. The monsoon-dependent agricultural sector, which employs a large share of the workforce, is particularly vulnerable to climate variability. Coastal regions face increasing risks from cyclones and sea-level rise, while urban areas are exposed to heat stress and flooding.
Given these conditions, climate-risk assessments are essential for Indian banks to understand how climate impacts may affect economic growth, credit demand, and asset quality. The Indian economy’s reliance on bank-based financing amplifies the importance of robust climate-risk assessment frameworks for maintaining financial stability.
India’s climate commitments under the Paris Agreement further highlight the need for banks to assess transition risks associated with decarbonisation and structural economic change.

Role of the Reserve Bank of India and Regulators

The Reserve Bank of India has increasingly recognised climate-related risks as a potential source of systemic financial vulnerability. The RBI has encouraged banks to develop internal capabilities for identifying and managing climate risks, improve climate-related disclosures, and integrate environmental considerations into risk management frameworks.
Indian regulators are also aligning with global best practices promoted by the Network for Greening the Financial System. These initiatives support the adoption of consistent methodologies for climate-risk assessment while allowing flexibility to reflect domestic economic and developmental realities.

Methodological Approaches in Climate-Risk Assessments

Climate-risk assessments in India typically combine qualitative judgement with quantitative analysis. Qualitative assessments involve evaluating governance structures, risk management processes, and exposure to high-risk sectors or regions. Quantitative approaches may include sensitivity analysis, scenario-based modelling, and portfolio-level exposure mapping.
Given data limitations, many Indian banks adopt a phased approach, beginning with high-level exposure assessments and gradually moving towards more granular, data-driven analysis. Advances in climate data, geospatial mapping, and analytical tools are expected to enhance the precision and usefulness of climate-risk assessments over time.

Implications for Banking Strategy and Financial Stability

Effective climate-risk assessments influence strategic decision-making in banks by shaping lending policies, investment strategies, and capital allocation. By identifying vulnerable exposures early, banks can reduce concentration risks and support a more orderly transition towards sustainable economic activities.
At the system level, widespread adoption of climate-risk assessments contributes to financial stability by reducing the likelihood of abrupt asset repricing and systemic shocks. It also facilitates the mobilisation of finance towards climate-resilient infrastructure and low-carbon technologies, supporting long-term economic resilience.