Climate-related financial data: Regulators should step in

The intersection of climate change and financial risk management has created a pressing need for reliable, comparable and affordable climate-related data. Traditionally, financial risk management relies on established and more predictable data sets. Since the historical relationship between climate change and finance does not hold, relying on established data will not help banks and financial institutions to make informed and meaningful decisions.

Climate-related financial data are new and unique, different from what they have traditionally used in financial risk analyses. In addition, the exorbitant costs of collecting and analysing such data are a significant challenge facing small finance banks and non-banking financial companies (NBFCs). Here is where regulators like the Reserve Bank of India (RBI) have a role to play. They can aid NBFCs, small finance banks, and other entities by enhancing climate-related financial information’s transparency, reliability, and comparability.

Data Gaps in Climate-Related Financial Information

Despite the growing recognition of climate-related risks, significant data gaps persist. For instance, while investors can access carbon emission data, it is often limited to Scope 1 (direct emissions) and Scope 2 (indirect emissions from purchased energy). Scope 3 emissions, which include all other indirect emissions that occur in a company’s value chain, are not as readily available. This is particularly true for industries like the automotive sector, where they are most relevant. Data from Micro, Small, and Medium Enterprises (MSMEs) is also largely unavailable.

Banks often have incomplete asset-level location data that fails to capture exposure of adaptive capacity to climate change risks such as heat waves, floods, precipitation and drought. Moreover, information on companies’ facilities, value chains and customers is scarce. The available data is not uniform across different agencies, leading to inconsistencies. For example, carbon risk ratings vary significantly between providers, adding to the confusion.

Lack of Uniformity Hampers Data Users

The lack of transparent, authentic and comparable data creates substantial challenges for financial decision-makers. Investors and depositors cannot differentiate between banks and financial institutions based on their financed emission intensity, the key indicator for assessing these institutions’ carbon risk.

Financial regulators, including the central bank, struggle to identify and measure climate risks, rendering regulatory measures ineffective. Without standardised data, regulated entities (e.g., banks and financial institutions) may make assumptions that present them in a favourable light, creating moral hazards. According to the Network for Greening the Financial System(NGFS), more than 65 organisations or private vendors provide different levels of emissions data, yet only seven of them are open sources. As a result, the data points are neither public nor auditable, creating transparency and authenticity issues.

Regulators can Bridge the Gap

Recently, Indian financial regulators, particularly RBI and the Securities and Exchange Board of India (SEBI) have developed several guidelines and recommendations on climate-related financial risks for their respective regulated entities. While the existing disclosure guidelines mark a critical development in integrating climate risks into India’s financial sector, regulators could also assist in enhancing the transparency, reliability and comparability of climate-related financial information.

Regulators can provide common data points that all the regulated entities must use. All the financial regulators can create a repository that collates all the aggregated and disaggregated public and private climate-related data material for the financial system. They can then publish it in one repository – for example, weather patterns to estimate financial losses from climate-induced extreme weather events and standardised methodology to calculate financed emissions.

For extracting the required data, regulators can rely on national agencies (e.g., metrological departments) to estimate climate-related physical risk data, which they can convert into some standardised and quantifiable financial risk. They can then store all the borrowers’ physical risks, which pertain to the impact of climate-induced weather events on a borrower or investee’s location, supply chain, and adaptive capacity, in a single database. All banks, financial institutions, and regulators can access this database.

Creating a single repository will allow all banks and financial institutions to use similar data points, improving consistency. Since it is a public database, it will allow even small finance banks and financial institutions to use these data points, creating a level playing field.

Building a Robust Data Infrastructure on Climate Change

Regulators can also build a robust data infrastructure for tracking and reporting financed emissions, physical risk exposure and transition readiness of banks and financial institutions. The above repository can help regulators to collect all the necessary data points from the data infrastructure. These data points will support regulators in better understanding and assessing climate-related financial risk in the financial system, thereby improving the supervision and regulation of their respective regulated entities. The data infrastructure will also help other decision-makers, such as policymakers and investors, measure climate risk in the financial system. Furthermore, decision-makers can also assess the green economic transition readiness of banks and financial institutions, which will aid them in making better decisions.

Investing in climate-related data repositories and infrastructure, improving risk management practices and ensuring regulatory compliance will be essential for Indian banks and financial institutions. Such steps will help the country transition to a low-carbon economy and manage the financial risks associated with climate change.

This article was first published in Financial Express.