When the Chennai floods struck in December 2015, the impact went far beyond waterlogged streets. Businesses shut, ATMs stopped working, and nearly ₹1 lakh crore in loans, largely to small businesses and the priority sector, were suddenly at risk (The Times of India, 2015). India has faced over 400 climate-related disasters in the past three decades, resulting in losses exceeding $180 billion (Down to Earth, 2023). The Reserve Bank of India (RBI) has recognised that these climate shocks are a threat to the financial stability of banks (Economic Times, 2023) and, in response, has directed financial institutions to conduct climate stress tests across their portfolios.
Beyond Traditional Risk Assessment
Traditional stress testing focuses on known historical variables like credit risk, default risk, market volatility, and operational factors. However, climate stress testing pushes institutions to consider forward-looking, climate-driven scenarios. This process is extraordinarily complex. Unlike conventional 3–5-year stress horizons, climate models may extend 30 years or more. Financial institutions need to address two main risk categories.
- Physical risks: Sudden shocks such as floods and cyclones, as well as gradual shifts like changing rainfall patterns or rising sea levels.
- Transition risks: Financial risks arising from the economy’s shift to low-carbon pathways, such as new regulations, carbon taxes, or disruptive technologies that may render fossil-fuel-dependent assets stranded.
RBI’s Regulatory Architecture
In February 2024, the RBI released its Draft Disclosure Framework on Climate-related Financial Risks. Anchored on four pillars of governance, strategy, risk management, and metrics & targets, this framework applies to all scheduled commercial banks (except specialised ones), large non-banking financial companies (NBFCs), Tier-IV Urban Cooperative Banks (UCBs), and All-India Financial Institutions.
The rollout will happen in the following stages.
While India is still developing its own frameworks, international experience shows why moving early is so important. The Bank of England’s 2021 stress test found that gradual carbon pricing cut financial shocks, while delayed action raises losses by ~30% (Bank of England, 2021). The Dutch central bank showed a sudden €100 carbon tax could wipe out €4.5–35.8 billion, but a phased rollout reduces the impact by ~50% (Boston Federal Reserve, 2021).
Implementation Challenges and Innovation Opportunities
Mapping physical risk – To accurately assess exposure, financial institutions must have detailed information regarding the specific locations associated with their loan portfolios. That means overlaying flood zones, heat maps, and other hazards on top of loan portfolios, whether it is farmland, factories, housing, or office space. The problem is that such data is not readily available. One way forward could be asset surveys or collaborations with insurers and weather agencies that already track such data.
Modelling transition risk – Stranded asset risk looks quite different across sectors such as energy, agriculture, or real estate. Right now, banks rely on global scenarios since India still does not have a dedicated carbon emissions database or sector-level net-zero pathways. The RBI itself has openly recognised these gaps. RBI Governor Shaktikanta Das explained, “Climate change is emerging as a significant risk to the financial system world over. This makes it necessary for regulated entities to undertake robust climate risk assessment, which is sometimes hindered by gaps in high-quality climate-related data. To bridge these data gaps, the Reserve Bank proposes to create a data repository, the Reserve Bank – Climate Risk Information System (RB-CRIS)” (The Economic Times, 2024). In the short term, international pathways from groups like NGFS or the IEA might fill the void, but still, a need exists for India-specific frameworks, databases, and scenario pathways (Bank for International Settlements, 2021).
Methodological gaps – Most existing stress test frameworks were designed for short-term financial cycles, not decades-long climate risks. As highlighted by institutions like CEEW and the BIS, long time horizons, uncertainty in projections, and knock-on feedback effects make modelling far more complex (CEEW, 2021). At present, many banks are taking incremental steps, starting with qualitative assessments of vulnerable sectors before gradually moving toward more data-heavy, quantitative models as the datasets improve. For Example, Kotak Mahindra Bank’s 2023 CDP filing noted that it had reviewed its loan book under two climate scenarios, RCP 4.5 and RCP 8.5, across short, medium, and long-term horizons. The exercise is still largely qualitative, highlighting which industries and geographies are most at risk, but the bank admits that turning this into hard numbers on financial losses will take time as better data becomes available (Kotak Mahindra Bank, 2023).
Technology and data standards – Data shortcomings remain a persistent barrier. In response, the RBI is working on RB-CRIS, a centralised repository to standardise definitions and make climate-risk data easier to access, even for smaller lenders. In parallel, emerging technologies are opening new possibilities: AI can now process satellite imagery fast enough to refresh risk maps regularly, and climate analytics providers are turning raw weather information into fiscal impact estimates. Global reporting frameworks like TCFD and the ISSB are setting the tone for climate disclosures, and India is starting to follow suit. The RBI’s 2024 Draft Disclosure Framework openly links its guidelines to TCFD and IFRS S2, asking banks to report on governance, strategy, risk management, and metrics and targets (RBI, 2024). Some lenders are already experimenting with this approach. Axis Bank, for instance, used its FY2022 sustainability report to release TCFD-aligned disclosures, highlighting a new Board-level ESG committee and outlining its climate strategy around the same four pillars (Axis Bank, 2022).
Building capacity – Perhaps the biggest challenge is people. Many banks simply don’t yet have the expertise to run climate stress tests. Big banks such as SBI are already strengthening their in-house capacity by setting up dedicated teams. The bank has put together a Climate Change Risk Management Committee and also built a horizontal business unit focused on ESG and climate finance. These steps show how SBI is starting to weave climate considerations directly into its lending practices and overall portfolio management (Times of India, 2024). But smaller banks will need regulatory hand-holding. Clear guidance, phased timelines, industry workshops, and shared modelling tools will be essential to raising the overall capacity of the sector.
Conclusion
Climate-proofing India’s banking system is about more than regulatory compliance; it is about resilience, stability, and competitiveness. Early action can protect balance sheets from growing climate shocks and unlock opportunities in green finance. By investing in better data, innovative tools, and human expertise today, India’s financial sector can not only withstand climate risks but also drive the country’s low-carbon transition.
By Kareena Jaisinghani, Senior Analyst, Climate and Sustainability Initiative (CSI). Views are personal.
References
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