This article originally appeared on Trucost and is republished with permission.

Banks and investors in India are exposed to $1,375 billion of natural capital costs due to the loans and investments they make to companies with environmentally damaging business activities, according to a new report published today.

The findings are published in the report Natural Capital Risk Exposure of the Financial Sector in Indiacommissioned by German International cooperation (GIZ) on behalf of the German Federal Ministry for Economic Cooperation and Development (BMZ) and conducted by consultants Trucost. YES Bank contributed to the study.

Natural capital refers to assets such as water, timber, land, a stable climate and clean atmosphere on which business and society depend to prosper and grow. India has a vast wealth of natural capital, but water scarcity, extreme weather and air pollution show this is not limitless. The Intergovernmental Panel on Climate Change (IPCC) has warned that unchecked climate change will exacerbate erratic rainfall patterns, heat waves, droughts and other extreme events in India. Tighter environmental regulation, consumer demand and marketplace competition may force companies to pay for these impacts in future, reducing shareholder value and threatening loan repayments.

The report finds that the total annual natural capital cost of companies financed by India’s banks is INR 90,496 billion ($1,375bn), equivalent to 2.9 times the credit provided to these companies. If companies had to pay these costs, it would significantly impact their profitability.

Indian banks are far more exposed to natural capital risks than equity investors because they finance higher impact sectors. Sectors with the highest natural capital costs include food, power and agriculture. The main impacts are water consumption and greenhouse gas emissions.

Industrial sectors together account for 28% of total natural capital costs while representing 43% of credit provided by banks. Of these sectors, food processing is the biggest single contributor at 12% of natural capital costs as a result of high levels of water consumption in its agricultural supply chain. The power sector accounts for 5% of industrial natural capital costs due to greenhouse gas emissions. Agriculture accounts for 71% of total natural capital costs while representing 13% of credit provided by banks due to the high natural capital intensity of activities such as cotton and wheat farming.

To mitigate these risks, the report recommends that financial institutions should quantify the natural capital costs of their loan books and investment portfolios. They should assess the risks of these costs becoming internalized by companies as a result of regulation or climate-related events. The approach to natural capital valuation taken by the report provides financial institutions with an excellent starting point.

Banks and investors should demand better data on natural capital impacts from companies to support natural capital valuation. Financial institutions could benefit by encouraging companies to reduce their natural capital impacts by using more sustainable production methods such as renewable energy and water-efficient irrigation.

Financial institutions should incorporate natural capital considerations into their analysis and decision-making processes. This is likely to require banks and investors to provide training to staff such as risk managers and credit analysts.

Yannick Motz, financial systems development adviser at GIZ, said: “All our economic activities depend on our ecosystems. However, the economic values of the goods and services provided by ecosystems have been neglected over decades. The approach to evaluate the pecuniary effects of environmental damaging business activities, outlined in the report, enables banks and investors to put a monetary value behind environmental impacts produced by borrowers or recipients of equity.”

Rana Kapoor, managing director and chief executive of YES Bank, said: “Valuing natural capital is extremely critical especially for financial institutions, and there is a need for collaborative action from governments and corporates together to deal with the challenges owing to externalities, which holds the key to limit global warming to less than two degrees. The report provides brilliant insights and recommendations to try and mitigate the natural capital risk exposure in India. YES Bank, driven by its responsible banking ethos, is a signatory to the Natural Capital Declaration playing an active role in developing innovative tools to support this transition to natural capital accounting.”

Richard Mattison, chief executive of Trucost, said: “There is growing concern that damage to India’s natural capital asset base will threaten economic growth. Financial institutions should move quickly to counter this risk by integrating natural capital considerations into corporate lending decisions and equity valuations.”

Natural Capital Risk Exposure of the Financial Sector in India is available to download at www.trucost.com/published-research/170/GIZ-natural-capital-risk-india
 

How could financial institutions encourage companies to reduce their natural capital impacts? 

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