Hi everyone,  

Welcome to the 152nd edition of The Pattern, a weekly where we dive into the latest from the world of economy, technology and finance. Let’s get started!  

Climate change is a threat – not just for our immediate health but for the future of the entire human race’s existence. However, a new front in the war is opening up. It’s because climate change is now threatening the core pillars of our financial ecosystem and increasing risk for lenders.  

Is India feeling this tremor?  

The answer is yes. Banks and lenders, along with interest rates and credit history, will now be forced to account for erratic monsoons, rising sea levels, and heatwave-induced crop failures. This is a massive change that could shake the foundations of our lending ecosystem and force a sizeable rethinking of processes and how we collect and interpret data.  

RBI Deputy Governor M. Rajeshwar Rao , at a recent summit, said, “Climate change would lead to additional operational costs for borrowers with an increased possibility of loss of their assets, leading to increased probability of default." 

What he addressed was not a hypothetical situation but a risk rising on the horizon. Agriculture, housing, and other climate-sensitive sectors are already reporting stress with rising NPAs, insurance gaps, and portfolio exposure that most are not equipped to manage.  

Here's how climate volatility is rewriting the loan book  

Climate change can impact borrowers in different ways. Due to extreme and unpredictable weather, borrowers face increasing operational costs like repairing flood-damaged machines or replanting failed crops.  

These costs pile up fast, exhausting the the money that was meant for loan repayments. And sometimes, the damage runs deeper. Storms, droughts, or floods can wipe out the very assets used to secure those loans. 

In more severe cases, businesses may be forced to shut down altogether, leading to widespread unemployment and further weakening the repayment capacity.  

These compounding effects make climate change a potent trigger for rising defaults. 

A steadily brewing boil-up  

In 2024 alone, extreme weather affected 3.2M hectares of cropland. For a country where more than 40% of the population depends on agriculture, these disruptions don't just impact food security but also weaken repayment capacity. 

As of March 2024, non-performing farm loans comprised 6.5% of total bad loans in Indian banks. Credit stress in the agricultural sector is boiling, but that's only part of the picture.  

The default risk is significant. According to an analysis by BCG , rising temperatures and climate volatility could increase default rates by up to 30% of agriculture and housing loan portfolios by 2030. 

India's shift to a net-zero economy is good for the climate but could be a difficult time for the banking sector in the medium term. India has committed heavily to clean energy, green infrastructure, and climate-resilient development. But many of these technologies, like hydrogen fuel or carbon capture, are still evolving, expensive, and commercially unproven. Since these sectors rely on long-term bank funding, lenders face higher credit risk due to long gestation periods and hard-to-price returns. 

"The fact that the net-zero technologies driving the transition to decarbonisation are at various developmental and evolving stages signifies a significant increase in credit risks," said Rao . 

Opening the floodgates of contradiction  

On one hand, the financial system must fuel India's green transition. On the other hand, it cannot afford to welcome high-risk bets that could destabilise balance sheets. 

"A delicate balancing act needs to be performed by the regulators to avoid any imbalance from the broader financial stability perspective," he added . 

To its credit, the RBI has initiated some structural responses. A draft framework has been released to standardise climate-risk disclosures across banks and NBFCs. It has also introduced a special ' On Tap ' cohort to test sustainable finance solutions. 

Unfortunately, most of India's banking sector isn't ready for either side of this equation. 

A recent report by Climate Risk Horizons assessed 35 of India's largest scheduled commercial banks and found that most are unprepared for climate-related financial risk. The findings were stark. Only seven financial institutions disclosed their full scope 1, 2 and 3 emissions . Most had no real green lending strategy. 

This lack of preparedness is deeply concerning and dangerous because we're now dealing with two kinds of risk: 

1. Physical risks: Floods, droughts, cyclones, and heat waves that damage assets and income streams. 

2. Transition risks: Market shifts, regulatory changes, and asset obsolescence in high-carbon sectors. 

Cracks in the foundation  

RBI's Rao highlighted that bridging this gap is complex. "Climate scientists are not experts in financial modelling, and financial modellers have limited expertise in the area of climate science," he said .  

This means Indian banks and regulators must invest in cross-disciplinary capabilities to build teams that understand both the effect of climate change and loan books, policy shifts and portfolio stress. 

The road to net-zero is clouded  

On the one hand, the financial sector must support green and sustainable finance. On the other hand, it must urgently address the rising risks emerging from climate disruption. If not managed carefully, both sides of the equation could destabilise the very system they aim to protect. 

Climate change has already priced into losses, defaults, and loan recovery cycles. And unless lenders, policymakers, and regulators treat it as core to credit risk, India's banking sector could gather a heap of mounting loan stress even before 2030. 

We need to act now! 

Reading List:  

1. New microfinance guardrails from June 1 while Tamil Nadu plans to regulate recovery operations  

2. Does parents’ default impact student loans?  

3. Bank lending growth slows to 12% in FY25  

4. Falling interest rates to pressure bank earnings; RoA to moderate from FY24 highs   

Thank you for reading. If you liked this edition, forward it to your friends, peers, and colleagues. You can also connect with me on X here and follow FinBox on LinkedIn to always get all updates. 

Cheers, 

Mayank