Should RBI Mandate Climate Change Norms?

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This only adds to the intrigue around whether the RBI’s well-intentioned green deposits framework is a good idea, but ahead of its time.

To put it in perspective, green deposits—just like regular deposit schemes offered by banks—will be governed by the same pricing norms. This means that green deposits will be priced at the same levels as regular deposits, but carry a higher indirect cost as the banks will have to provide third-party verification of how the funds were used. There is little incentive for a bank to issue green deposits if there is no cost advantage.

Additionally, banks will have to find adequate good quality projects to lend such green funds to, or run the supervisory risk of having to explain why it was not able to deploy these deposits.

Are green deposits a good idea? On paper, the answer is yes.

But, existing norms on deposit pricing—that aim to protect retail customers from getting a lower pricing than bulk deposits—will mean that deposits of similar tenure for green and regular deposits will likely end up being priced similarly. A lower pricing on green deposits offered by a bank will likely prevent interest rate-sensitive retail depositors from opting for such deposits, no matter the noble intent behind the bank’s offering.

This leaves the small bulk depositor base comprising high network investors, who may be tapped by such banks for green deposits. This is a small pool when compared to the size of the depositor base.

While it is true that some banks have been offering green deposits already, there is little data to tell us what the volumes are or how these funds have been deployed so far. Additionally, banks have been lending to such green or sustainable projects for some time now, and RBI’s intent seems to be to provide even lower cost funding for such projects through the nudge of green deposits. 

While providing an enabling framework for pushing sustainable finance is a good step, should RBI be pushing banks to lend more to such projects that are climate-friendly or stopping banks from lending to polluting sectors.

The bigger question that then emerges is whether central banks should be mandating such measures aimed at tackling climate change or whether this should be a business decision best left to banks. Could RBI be seen as interfering in business decisions of banks that should be left to the wisdom of the management and board of directors of banks? 

Additionally, since the government is the one making commitments on climate change at a global level, isn’t it a policy decision that the government has to take on whether to provide support for credit to climate-friendly projects or penalise those lending to polluting units. 

While the RBI has so far been enabling loans to climate-friendly projects and not mandating it, is there a risk that the central bank’s inputs may be interpreted by regulated entities as a directive?

By effectively asking banks to lend to more climate-friendly projects, we may be adding the risk that banks may shy away or charge more to projects that pollute more but are necessary for growth that a developing country like India needs. In a country like ours, which still needs to provide necessary resources and jobs to all citizens, it is difficult to bat for climate-friendly practices without being seen as anti-development. 

This leaves a central bank, such as the RBI, at the risk of influencing flow of bank credit, even as government policy has not officially taken a call on such businesses. 

The RBI’s green deposit programme and support for sustainable financing is a noble move and in line with the global push towards more climate-friendly policies. 

But, as a central bank that has a stated monetary stability mandate coupled with a clear inflation target for monetary policy, the RBI is stretching its mandate when it veers into such policies.

If the RBI believes that there is a need to move away from lending to polluting industries, it needs to work with the government to push companies to move towards more climate-friendly practices. It can also use its supervisory powers to understand whether banks excessively lend to polluting sectors and cite global best practices to exhort banks to reduce their dependence on such sectors for future growth.

If its stress tests indicate excess reliance on such polluting sectors, the RBI can even push banks to take on credit insurance against climate risks or even consider higher risk weights as an extreme measure. This will act as deterrents without being seen as a diktat.

This is not to say that the RBI should not be working on areas such as green finance or sustainable finance or related issues. Instead, it must look to supplement government policies on these issues rather than issuing targeted mandates on who banks must lend to.


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