In a progressive move, the Reserve Bank of India (RBI) is one of the first central banks and financial regulators in the world to release a framework for accepting ‘green deposits’[1] (“GD Framework”).
This in the backdrop of:
(i) the RBI joining the Network for Greening the Financial System (NGFS) in April 2021 – which is a coalition of central banksand prudential supervisory authorities from across the world, committed to voluntarily exchanging experiences, sharing best practices, mobilising mainstream finance for greening the financial ecosystem[2];
(ii) the discussion paper on ‘Climate Risk and Sustainable Finance’ (“Discussion Paper”) released by RBI in July 2022, which outlines the strategy for the financial system to move towards green financing based on global best practices and ensure long term financial stability[3]; and
(iii) the Statement on Developmental and Regulatory Policies issued in February 2023 wherein the RBI has announced that it will issue guidelines[4] for regulated entities (“REs”) in relation to: (a) disclosures; (b) stress testing and scenario analysis; and (c) green deposits.
The financial markets are not insulated from the risks of climate change, nor should they be from taking action to mitigate its effects. In a recent speech by the RBI Deputy Governor, it has been acknowledged that banks and other financial institutions also have a key role to play in the transition towards a low-carbon economy and supporting the national climate commitments[5].
In India, various banks like HDFC, IndusInd, DBS India, etc. have voluntarily launched one such innovative product called green deposit. It allows eligible clients to have their deposits invested in green initiatives. Green Deposits are a means of channelling depositor savings into environmentally beneficial projects (which needs sources of funding) and enabling depositors to earn potentially higher returns from such investment. However, given the nature of the product, concerns regarding depositor protection and the risk of greenwashing, urgent regulatory supervision by the RBI became necessary. Although such green deposits exist in other jurisdictions such as the UK, Portugal and Australia (usually as a structured deposit project for HNI private clients), there is currently no regulatory framework for such products, making the RBI’s GD Framework a pioneering move aimed at protecting depositors as well as inculcating prudential and disclosure discipline.
RBI’s GD Framework is expected to come in force on June 1, 2023. Some of the broad themes which can be observed in the GD Framework and are likely to be made part of the rest of the green taxonomy are:
(i) Applicability
There is no uniform definition of ‘regulated entities’ across RBI circulars, and the definition varies depending on the context for each circular.[6] In the context of green deposits, the RBI has primarily limited the definition to scheduled commercial banks (including small finance banks and excluding regional rural banks (RRBs), local area banks (LABs), payment banks) and deposit taking NBFCs. This is a thoughtful consideration by the RBI to limit the scope of green deposits. RRBs, LABs and payment banks might not be able to deploy such resources on account of their size, capital, liquidity constraints.
(ii) Design
Green deposits are designed in a way that is akin to a fixed deposit i.e. interest bearing and for a fixed period, subject to withdrawal or renewal at the option of the depositor. The only difference is that the proceeds will be earmarked for investment by REs in eligible green projects set out under the said notification.
(iii) Tone from the Top
Board oversight and supervision play a critical role in achieving regulatory and strategic objectives, with directors’ liability acting as an important check. The RBI has rightly implemented the same by mandating a board-approved policy requirement and a board-approved financing framework for funds raised through investment in green deposits. In addition, the GD Framework requires a review report to be placed by the RE before its board of directors within three months of the end of the financial year. The underlying theme of imposing responsibility on the board of directors in relation to sustainable finance was evident in the Discussion Paper and has to an extent been reflected in the GD Framework. The RBI had recognised that the board of directors would also have to exercise effective oversight on risk management and controls and ensure that sufficient internal / external expertise is available for managing the financial risks arising from climate change and environmental degradation. To facilitate effective oversight, the board of directors and senior management may regularly seek relevant management information, as well as be apprised of major policy initiatives and developments concerning climate-related and environmental issues. Going forward, this ‘tone at the top’ will play a crucial role and it would be prudent for REs to invest resources in hiring people with appropriate expertise, capacity building, upskilling, training, and workshops for senior management to implement climate strategy.
(iv) Disclosures
The notification requires REs to make appropriate disclosures in their annual financial statements regarding green deposit funds. Additionally, there is a requirement to upload a copy of the policy on ‘green deposits’, ‘financing framework’, opinion of the external reviewer and the third-party verification/assurance and impact assessment report on the respective websites of REs. The issuance of green deposit has been closely tied with the provisions on disclosure, so that depositors are aware of investments made by the REs in the prescribed green projects, which can be closely tracked and audited. Such disclosures could also act as a check on greenwashing by relevant entities. While third-party verification and assurance is useful in providing some credibility to investments using depositor money, it is no panacea. It could in fact, bring its own risks, in the absence of a regulatory framework and accountability for such assurance providers. Further, it could lead to a false sense of complacency. In the medium term, the RBI could consider requiring both internal and external audit as well as strengthen its supervision of such investments. We will be separately analysing ‘Disclosures’ as part of the larger regulatory framework for climate finance in a subsequent post.
(v) Third party audit
In addition to the primary responsibility of the board to comply with the GD framework including end-use of funds allocated for green deposits, the RBI has placed an additional check by way of subjecting REs to an independent third-party verification/assurance, to be done annually. Given that impact assessment is an evolving area, the RBI has been liberal in its approach, which is evident in its prescription allowing voluntary undertaking of such assessment for the financial year 2023-24. However, the same will be mandatory from the financial year 2024-25 onwards. Further, the RBI has set out certain impact indicators for each category of eligible project, for example, in relation to clean transportation, the indicator would be ‘energy savings per year’. In case REs are unable to quantify the impact of their lending/investment, they will be required to disclose, at the minimum, the reasons, the difficulties encountered, and the time-bound future plans to address the same. This ‘comply and explain’, solution-oriented, flexible and forward-looking approach of the RBI provides some agility to REs. However, there is an issue for depositors. Since their funds are being invested in ostensibly green projects, there will be a need to ensure alignment between the commitment and actual investment, as well as protection of the investment and regular review and monitoring.
Additional considerations
Framing the GD Framework is a remarkable first but raises certain additional questions and issues for the RBI to consider. These are:
(i) Deposit Insurance
With recent international bank collapses and Indian NBFC insolvencies, depositors would be reasonably worried about all deposits, including green deposits. In this regard, a formal clarification from the RBI on such deposits being insured by Deposit Insurance And Credit Guarantee Corporation (DICGC) for an amount up to INR 5,00,000 (Rupees Five Lakhs)[7] will give some respite to interested investors and also encourage participation. Considerations on deposit insurance, structuring such investments to protect uninsured deposits and interest on such deposits are all matters of regulation, supervision and when required, enforcement, thereby, safeguarding public interest.
(ii) Maturity transformation and returns
Although structured as fixed deposits, there is a real risk of maturity transformation and related asset-liability mismatches of REs, given the much longer horizon of green investments and shorter deposit periods. This could be a prudential concern for the regulator as well since it could have liquidity and other capital implications. It has a consumer and depositor protection dimension as well given that funds will need to be available at the end of the tenor of the deposit, or even in the interim, subject to a penalty or charge. In addition, green projects receiving funding from such sources could require certainty of funds and their tenor. Accordingly, the RBI may consider prudential norms for green investments made through funds raised from green deposits.
(iii) Consequences for non-compliance
It must be noted that while the RBI issued this notification to safeguard depositors’ interest and augment the flow of credit to green activities, REs are not bound by specific mandatory targets, nor are there any penal provisions in case they breach these guidelines. It might also be relevant to have provision for depositors to raise grievance with REs and escalate if need be, in the event there is a discrepancy in the end-use of these funds.
With the increased awareness about the threats of climate change, many customers and investors are seemingly more inclined towards businesses, which are environment friendly. In a way, this notification provides a potential, predictable and low-cost source of funds for green deposits and could, in the medium term, raise costs for projects which are not covered under priority sector lending guidelines (PSL) or green deposit schemes. It is time for such businesses to gradually start pivoting towards green practices without jeopardising the livelihood of their employees or environmental externalities, as banks might shift their focus on lending to green or environment, social, governance (ESG) compliant projects on account of regulatory as well as commercial and existential imperatives.
Since 2020, the RBI has been promoting lending to renewable energy projects by way of the PSL guidelines[8], green deposits will further incentivise investments in sunrise sectors like green hydrogen, electric vehicles, green buildings, etc. There is also an increased inflow of investments from multilateral organisations like International Finance Corporation in relation to green finance. This presents a unique opportunity for REs to augment their climate finance portfolio, including engaging in risk-sharing models with multilateral organisations for financing of carbon-neutral projects.
While the RBI is actively reviewing and analysing the stakeholder feedback on the Discussion Paper to frame policies for REs, banks and financial institutions should also be prepared to step up their engagement with corporate customers on ensuring sustainability-focused financing and services to help them transition towards a low-carbon economy while reducing their own carbon footprint. A formal green taxonomy is awaited by the financial sector as it will enable uniform and consistent disclosures, effective internal design policies, scaling up of green and sustainable finance and mitigating the risk of greenwashing.
For further information, please contact:
Richa Roy, Partner, Cyril Amarchand Mangaldas
richa.roy@cyrilshroff.com
[1]Framework for acceptance of Green Deposits, April 2023, available at: https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12487&Mode=0
[2]RBI joins Network for Greening the Financial System, April 2021, available at: https://rbidocs.rbi.org.in/rdocs/PressRelease/PDFs/PR1310A00813402454FD398F0695FE7234542.PDF
[3]Discussion Paper on Climate Risk and Sustainable Finance, Department of Regulation, RBI, available at: https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/CLIMATERISK46CEE62999A4424BB731066765009961.PDF
[4] Statement on Developmental and Regulatory Policies issued on February 8, 2023, available at: Reserve Bank of India – Press Releases (rbi.org.in)
[5] Challenges and Opportunities in Scaling up Green Finance, Shri M. Rajeshwar Rao, Deputy Governor, Reserve Bank of India, December 2022, available at: https://rbidocs.rbi.org.in/rdocs/Speeches/PDFs/BSBFSISUMMITF9F9354E0E074B9DAC7DC5D38AA78559.PDF
[6] For instance, RBI Master Directions on KYC dated February 25, 2016 defines ‘REs’ to inter alia cover All India Financial Institutions (AIFIs), All Payment System Providers (PSPs)/ System Participants (SPs) and Prepaid Payment Instrument Issuers (PPI Issuers) etc. whereas RBI Master Directions on Outsourcing of Information Technology Services dated April 10, 2023 define ‘REs’ to inter alia cover Credit Information Companies, EXIM Bank, NABARD, NaBFID, SIDBI etc. We note that the Discussion Paper is meant to be applicable to ‘regulated entities’, however the term has not been defined therein. Accordingly, the final regulations by RBI in relation to ‘Climate Risk and Sustainable Finance’ should clearly describe the ambit of ‘regulated entities’.
[7] Deposit Insurance and Credit Guarantee Corporation (DICGC) increases the insurance coverage for depositors in all insured banks to ₹ 5 lakh, February 4, 2020, available at: https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=49330
[8] Master Directions – Priority Sector Lending (PSL) – Targets and Classification, September 2020, available at: https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=11959#Renewable_Energy
