Financial institutions: Time for Leadership

The economists, policy makers and business leaders are recognizing the financial rewards from controlling climate change. Onus is on the Indian and International financial institutions to provide the lead to enable the required economic transformation for a strong and successful low carbon economy.

Climate change mitigation

An overwhelming body of scientific evidence now clearly indicates that climate change is a serious and urgent issue and that the earth’s climate is rapidly changing, predominantly as a result of increases in greenhouse gases caused by human activities. Climate change is already evident from observations of increases in global average temperature, sea level rise, precipitation changes, and extreme weather events.

The Indian National Action Plan on Climate Change has become central to setting India on a low carbon development path. Last year Government approved a national trading scheme for Carbon Credits and energy-efficiency certificates that it claims could be worth more than 750 billion rupees (US$15 billion) by 2015. This represents significant opportunity and clearly incentivizes financial institutions like banks to provide capital for large-scale infrastructure and low carbon technology deployment. The proposed perform; achieve-and-trade scheme also incentivizes institutions through partial risk guarantees for lending to energy efficient projects.

Even in the absence of certainty around climate regulations and policy, there are sufficient commercial drivers for finance institutions to be proactive in facilitating the transition to a low carbon economy by dedicating greater amounts of finance towards renewable and clean energy projects. Internationally, institutions realize that responsible finance is no longer a marginal issue but a matter of good business practice. The proliferation of frameworks and protocols to this effect further testifies to the urgency.
A primary focus of the Government of India is on maintaining economic development and alleviating poverty and it is unlikely that the Government will entertain or implement policies that will in any way jeopardize these primary objectives. Nevertheless, the opportunities for businesses and financiers that are emerging—both domestically and internationally—as the world moves on to a lower carbon development, are ones that India cannot afford to pass up.

Financial institutions can carefully evaluate which areas would be most complementary to their inherent organizational structure and ideology. Budget allocations may be set aside and cost benefit analysis completed. Cost implications will only exist as long as banks view climate change initiatives as a cost centre for philanthropic purposes. As soon as banks can capitalize on the inherent opportunities which are now available, the concern over costs will diminish.

Several banks operating in India have already made inroads into the wealth of opportunities which are now available as highlighted.

• The State Bank of India (SBI), as part of its Green Banking Policy, will set up windmills to generate 15 MW of power in Tamil Nadu, Maharashtra and Gujarat for its own consumption. SBI was the first Bank in the country to think of generating green power as a direct substitute to polluting thermal power and implement the renewable energy project for captive use.
• ICICI Bank has been assisting various organizations to undertake clean energy and environmentally sustainable projects/initiatives. ICICI Bank has assisted projects that would specifically promote energy efficiency, renewable energy, biomass co-generation, biomass gasification, demand side management (by utilities), waste heat recovery, energy service companies (ESCOs) that demonstrate substantial savings in energy on a shared savings basis as well as projects that lead to pollution prevention and waste minimization at source.

The key to the success of any financial institutions lies in the estimation of inter-relationship between their assets and their liability, and understanding how these two groups will evolve over time. The optimization of the return and duration of assets in respect of liability commitments is perhaps hindering a well-managed and enlightened growth of low carbon practices. To date, climate change impacts have only influenced financial decisions at the margins, if at all.

Dwindling Environment Business sector

The environmental business sector has a critical role to play in achieving sustainable development and mitigating climate change, thus ensuring their access to finance is crucial. Despite apparently good prospects, with rapidly growing markets, the financial performance of the sector has been disappointing to date. Indeed, the poor performance of many high profile companies has been a major factor in creating a negative impression about the Climate change with financial institutions. A number of factors are identified for this. Several of them are closely related to the public sector and policy issues, both in the way that the environmental markets are often dependent on policy development and the active role of public sector finance in this area.

In response to the challenges faced by environmental sector companies, a number of innovative approaches and specialist organizations have emerged, including project finance, venture capital, leasing, environmental and ethical banks, specialist environmental financiers, and environmental funds. However, the sector may place excessive emphasis on emerging sources of finance or stretch existing finance into new areas and there is a continuing need for innovation. To encourage the financial markets to support the sector, there is a need for measures at both a macro level, such as clear policy development and dissemination, and micro level, such as training on financial markets for environmental entrepreneurs.

Suggested strategy: opening new doors

In today’s scenario strategy of finance institutions should be integration of climate change in all departments and regions, including advisory services, as a model for the larger world of commercial finance in emerging markets. Some of the tactics which can be implemented are:

• Promotion of climate friendly investments using commercial funds. Financial institution should pledge to grow energy efficiency and new renewable energy lending by setting their targets. For ex: IFC clean energy lending grew at an annual average of 51% per fiscal year over the last four fiscal years -- from $221 million in FY05 to $1,034 million in FY09.
• Cleaner production. Offer to existing and new clients, a combined package of cleaner production audits and financing to implement recommendations for improving energy and resource efficiency through low cost, high return measures.
• Clean technology. Investments in early stage clean tech companies and private equity funds are most required. Investments in early stage climate friendly technologies should be centrally coordinated with overall targets, across all sectors and industries, through various departments.
• Carbon finance. Introduction of value-added financial products to help mitigate risks in the carbon market by leveraging their ability to take long-term project and risk in emerging markets. For ex: IFC, which is AAA-rated, offers a Carbon Delivery Guarantee for credits from projects in developing countries. This product helped maximize the value of carbon credits generated from a waste heat to power project at an Indian chemical company.
• Sustainable investing. Working with public pension funds and other long-term asset holders to promote investment in sustainable businesses in emerging markets can bring revolutionary change. By making a small shift in the trillions of dollars managed by these funds, it may be possible to generate a large source of additional resources for climate friendly investments.
• New analytical tools to better understand risks and opportunities. Development of new methods to calculate the carbon footprint of investments, testing the implications of assigning a price to carbon as a proxy for climate change costs, identification of financial risks of climate change, and evaluation of how corporate value may be differentially affected by climate change policies, can add significantly to the performance standards, which require reporting of emissions from projects expected to result by financial institutions.
• Outreach and collaboration with other stakeholders. A healthy relationship with the Equator banks and sharing of experience with international business organizations like the World Business Council for Sustainable Development and the World Economic Forum can provide an important link between climate change-related business practices and evolving best practices like carbon disclosure by IFC.

References:
CLIMATE CHANGE AND FINANCE IN INDIA: Banking on the low carbon Indian economy may 2010, commissioned by Climate Group, Indian Bank Association and Price Waterhouse Coopers.
The role of financial institution in achieving sustainable development: Report to European Commission by Delphi International LTD. In association with Ecological GMBH, November 1997.
Climate Change and India- Some Major Issues and Policy Implications by H.A.C. Prasad and J.S. Kochher, Department of Economic Affairs Ministry of Finance, Government of India, March 2009.

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