Dynamic Climate Risk Assessment in the Indian Banking Sector
A forward-looking framework for quantifying climate-related financial risks across Indian banks through interactive scenario analysis and real-time parameter adjustments.
Executive Summary
This case study presents a dynamic, forward-looking framework for assessing climate-related financial risks in the Indian banking sector. Building upon NGFS, TCFD, and PCAF principles, this study introduces an enhanced interactive model that allows real-time scenario analysis and dynamic parameter adjustments.
The model quantifies the impact of various climate pathways on key banking metrics including credit risk, capital adequacy, and liquidity, culminating in a composite Climate Risk Resilience Score (CRRS). Through comparative analysis of different Indian bank archetypes, the study demonstrates heterogeneous impact across the sector.
Key Highlights
  • Interactive Python-based model
  • Real-time scenario analysis
  • Three bank archetype comparison
  • CRRS composite metric
The Enhanced Climate Risk Framework
This framework enhances traditional climate risk assessment by incorporating dynamic scenario generation, macro-financial linkages, and granular risk modules. The approach explicitly models transmission of climate shocks to the broader economy whilst maintaining double materiality assessment.
Dynamic Scenario Generation
Real-time updates and customisation of climate scenarios with interactive parameter adjustments
Macro-Financial Linkages
Explicit modelling of climate shock transmission to broader economy and financial system
Granular Risk Modules
Detailed assessments of credit and liquidity risks at sector and portfolio level
Dynamic Climate VaR
Forward-looking, probabilistic measure of potential climate-related financial losses
Double Materiality
Assesses both climate impact on bank and bank's impact on climate
Interactive Web Application
A Python-based working model was developed to implement the enhanced framework, simulating impact of NGFS scenarios on sample bank portfolios with dynamic adjustments to carbon prices and physical risk multipliers.
Select Bank Archetype
Choose from public sector, private sector, or mid-sized bank profiles
Choose Climate Scenario
Select from NGFS scenario pathways including orderly, disorderly, and hot house transitions
Adjust Parameters
Dynamically modify carbon prices and physical risk multipliers in real-time
Analyse Impact
View real-time impact on risk metrics, financial assessments, and visualisations
Portfolio Risk Profile Analysis
The radar chart illustrates the risk profile of a large public sector bank across four different NGFS scenarios, highlighting trade-offs between risk dimensions under various climate pathways.
Key Observations
Orderly transition scenarios present higher transition risk with lower WACI and BER scores, whilst resulting in lower physical risk and higher overall resilience through the CRRS metric.
The trade-off between transition and physical risk becomes evident across different scenario pathways, informing strategic portfolio decisions.
Cross-Bank Resilience Comparison
The heatmap compares Climate Risk Resilience Scores (CRRS) of three bank archetypes across all NGFS scenarios, revealing significant differences in climate risk exposure.
1
Private Sector Advantage
Lower exposure to carbon-intensive sectors results in significantly higher resilience scores across all scenarios
2
Public Sector Vulnerability
Higher fossil-fuel intensive portfolios create material climate risk exposure, particularly under disorderly transitions
3
Hot House Threat
High physical risk scenarios pose greatest threat to all banks, emphasising need for comprehensive risk management
Sector-Level Risk Analysis
Detailed breakdown of climate risk impact by sector for the public sector bank under a disorderly delayed transition scenario reveals primary drivers of increased credit risk.
High-Risk Sectors
Thermal Power and Steel & Metals represent primary sources of increased credit risk exposure.
These sectors demonstrate highest increases in Probability of Default (PD) and Expected Loss (EL) metrics under stress scenarios.
Capital Adequacy Impact
Climate-related risks significantly impact bank capital adequacy, with notable erosion of CET1 capital ratios under different scenario pathways.
2.3%
Public Sector Erosion
Maximum CET1 erosion under disorderly scenario
1.5%
Private Sector Erosion
Lower capital impact due to portfolio composition
1.8%
Mid-Size Bank Erosion
Intermediate vulnerability profile
The public sector bank experiences most significant capital erosion under disorderly and hot house scenarios, highlighting vulnerability to climate shocks and need for enhanced capital planning.
Sensitivity and CRRS Breakdown
Sensitivity Analysis
Varying carbon price and physical risk multiplier demonstrates impact on CRRS and CET1 erosion for public sector bank.
CRRS Component Breakdown
Composite score derived from six underlying components reveals sources of vulnerability.
Higher carbon prices and greater physical risk lead to lower resilience and increased capital erosion
Bank's low resilience primarily driven by high transition risk and low green alignment scores
Dynamic parameter adjustments enable stress testing under extreme but plausible climate conditions
Conclusions and Recommendations
This case study demonstrates power of dynamic, forward-looking approach to climate risk assessment, providing practical tools for banks and regulators to navigate complex climate-related financial risks.
Key Findings
Climate risk represents material threat to Indian banking sector with significant impact on credit risk, capital adequacy, and liquidity
Impact of climate risk is highly heterogeneous, with portfolio composition and transition readiness determining resilience
Dynamic, scenario-based approach essential for capturing forward-looking and uncertain nature of climate risks
Robust governance and strategic planning critical for navigating transition to low-carbon economy
Strategic Recommendations
Integrated Climate Risk Assessment
Banks should adopt dynamic, integrated approach incorporating climate risk into core risk management frameworks and strategic planning processes
Proactive Portfolio Rebalancing
Reduce exposure to carbon-intensive sectors whilst increasing financing of green and transition assets
Regulatory Guidance
Regulators should provide clear guidance on climate risk management and incorporate climate stress testing into supervisory frameworks
Industry Collaboration
Collaborate to improve data availability, modelling capabilities, and develop common understanding of best practices
By implementing these recommendations, Indian banking sector can build resilience to climate-related financial risks and play key role in financing transition to sustainable, low-carbon economy.
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