The treatment of physical climate risks by central banks

Emerging market economies (EMEs) like India are highly vulnerable to the physical impacts of climate change. A significant proportion of GDP comes from climate-sensitive sectors and most households have insufficient savings to guard against or recover from climate shocks. The economic ramifications of climate change in India and other EMEs could be severe, and as such, the financial sector is moving to secure itself against climate risk.

Central banks, financial authorities and their associations have outlined principles and guidelines for assessing the financial sector's exposure to climate risk, including enhanced data gathering, regular conducting internal stress tests, and board-level involvement on climate risk, to name a few

The Reserve Bank of India (RBI) recognises the climate challenge and is engaged with the Indian financial sector on climate risk management. This paper aims to contribute to these efforts. It draws on structured interviews with officials of selected central banks in June–August 2023 and literature reviews of selected central bank reports to understand their physical climate risk assessment and disclosure regimes.

The paper concludes with a roadmap including 9 suggested action points that for the RBI may consider as it develops its policies on climate scenario analysis, stress testing and disclosure requirements.

Key Messages

Practical experience from selected central banks highlight advantages to undertaking a phased approach with clear timelines to implement physical climate risk assessment policies.

It is important to consider the principle of proportionality during implementation of such policies in view of variations in technical capacities and the systemic importance of regulated entities (REs).
Central banks pointed to serious challenges in terms of data availability, modelling risks and varied capacities of REs. In this context, current policy efforts aim at enhancing REs’ capabilities to manage physical climate risks, rather than modifying capital requirements.
The Reserve Bank of India has taken critical steps to raise awareness among REs on climate issues, and it is important not to lose this momentum by setting clear and ambitious timelines on the next policy steps.