It is now a proven fact that climate change is happening across regions. As a result, many sectors are impacted which is now profoundly visible. Also, it is estimated that the impacts will become destructive in the future making climate change one of the major challenges of current time.

With many sectors already affected by climate change, Banking and Financial Institutions (BFIs) are also affected. BFIs play a vital role in meeting climatic commitments mostly in the form of green financing.

But they are also vulnerable to climate-related risks as they are tied to every market component through their lending processes. According to IPCC, these risks are broadly classified into two broad categories: physical and transition risks.

Physical risks involve risks to facilities and infrastructure, impact on business operations, raw material availability, and supply chain disruptions.

Physical risks have direct financial consequences such as an impact on collateral accepted by banks and a reduction in the value of the collateral.

On the other hand, these risks deteriorate the ability of the borrowers to repay the loan. This increases the credit risk and ultimately banking system.

In 2022 Nepalese BFIs provided 23% of loans and advances in agroforestry and fishery-related sectors. The energy sector received 5%, and the mining and construction sector received 4% advance and loan during the same period.

Transition risk arises from changes in climate-related policies and technologies, the emergence of new climate-friendly technologies, and changes in consumer preferences.

Transition risk can result in stranded assets, loss of markets, and reduced returns on investment and penalties. Also, failure to adapt to climate risk may have reputational risk from governments.

If these risks are not managed adequately and timely, they can pose financial and credit risks, economic disruption, and insurance losses for the BFIs. Hence, it is of utmost importance to promote resilience to climate-related risks in the BFIs.

Climate Change Scenario in Nepal

According to NASA, the average global temperature on Earth has increased by at least 1.1° Celsius since 1880. 2015 to 2022 are the eight warmest years on record.

The exceedance of the 1.5° Celsius benchmark set by the 2015 Paris Agreement reciprocates to turning up the dial on extreme weather events.

Nepal is ranked as one of the most highly vulnerable countries to the impacts of climate change. Nepal is ranked 126^th out of 182 countries in the 2020 ND-GAIN Index.

The ND-GAIN Country Index is the measure of vulnerability to climate change and other global challenges in combination with its readiness to improve resilience.

According to the Ministry of Forests and Environment, the annual maximum temperature has increased to 0.056⁰C per year. Such warming is higher at higher altitudes. Nepal’s temperature is projected to increase by about 0.9 C between 2016 and 2045.

Some of the noticeable impacts include increased natural disasters, reduced agriculture productivity, food security, increased forest fires, loss of forest and biodiversity, and drying of water resources. Winters are projected to be drier and monsoon summers wetter, with up to a threefold increase in rainfall.

IFC states that winters are projected to be drier and monsoon summers wetter, with up to a threefold increase in rainfall. The number of people annually affected by river flooding caused by climate change could double to around 350,000 in 2030.

According to the World Bank Group’s Country Climate and Development Report for Nepal, Nepal’s GDP could be at least 7% smaller by 2050 due to unchecked climate impacts. Agriculture is one of the hardest hit by climate change in Nepal, as the share of agriculture in GDP is about 24% in 2021/22.

Nepal’s agriculture-based economy is strongly connected with other economic sectors such as industries leading to strong ripple effects.

Most importantly, a large proportion of the population relying on subsistence agriculture for livelihood is affected. Natural disasters also disrupt road networks and impact negatively trade.

Similarly, Nepal’s promising sector of hydropower is vulnerable to climate change. With increased climate variability, it can affect the frequency and intensity of flooding, GLOFs, and droughts that could affect electricity production. Along with that, the hydropower infrastructure can be damaged due to increased extreme events.

More than 80 percent of property loss is attributed to climate hazards with particular emphasis on water-related events. This will only be exacerbated with the ascent of climate change.

Nepalese BFIs

BFIs in Nepal are institutions that have obtained licenses under the Bank and Financial Institution Act, 2073 (2017) for carrying out banking or financial transactions. According to Nepal Rastra Bank (NRB), Nepalese BFIs offer loans and advances in various sectors of the economy.

Though the Nepalese banks along with the central bank are committed to work towards appropriate action, it is pivotal that a move towards integrating climate-friendly measures be taken as a way to face the climate change challenges head-on. Hence, ignorance of climate issues is no longer an option.

In 2022 Nepalese BFIs provided 23% of loans and advances in agroforestry and fishery-related sectors. The energy sector received 5%, and the mining and construction sector received 4% advance and loan during the same period.

Agriculture and fisheries are highly vulnerable to climate change as per the Intergovernmental Panel on Climate Change (IPCC). The IPCC is the scientific group to monitor and assesses all global science related to climate change.

In a study done by Deloitte, agriculture, conventional energy, heavy industry, manufacturing, transport, and construction have a significantly higher level of risk compared to others.

These sectors are highly vulnerable to climate change due to the large workforce engaged that is highly exposed to climate extremes.

Overall, the loan and advance disbursed by the Nepalese BFIs lie in the highly climate-sensitive sectors making BFIS at high risk of climate change. Projections estimating an increase in climate change impacts have made BFIs on the verge of immediate action.

Why do BFIs require immediate actions?

There are financial and non-financial benefits to addressing climate risk in BFIs. Key reasons why Nepalese banks should address climate risks.

International Commitment to climate change

Nepal is a signatory of the international climate agreements. United Nations Framework on Convention for Climate Change (UNFCCC) and the Paris Agreement are the two major ones. Also, Nepal has committed to Sustainable Development Goals (SDGs). All these international climate change agreements have promoted BFIs to finance projects that address climate change.

Increased customer awareness

The BFIs clients have increased awareness of climate change and posed risks. They can play an important role in making climate-friendly decisions.

This has put pressure on the business to address climate-related issues in their life cycle. To do so they need financing from BFIs. So, BFIs with sound climate-friendly instruments are paramount.

Enhanced reputation

The stakeholders/investors are looking at BFIs not only through financial terms but they are also looking at it through climate-friendly measures.

BFIs are seen traditionally through corporate social responsibility (CSR), but now banks have shifted to a more strategic approach of integrating that into the overall financing process. Such initiation increases the reputation of the banks in the long term.

Increasing BFIs Resilience to climate change

Climate poses significant risks for operations, investments, and loan portfolios of BFIs, and addressing these risks is not just a good marketing strategy but is a smart business decision. Such smart decisions will help BFIs in promoting green economic transformation.

Conclusion

It is now a proven fact that climate change has an impact on banks directly or indirectly either sooner or later.

Though the Nepalese banks along with the central bank are committed to work towards appropriate action, it is pivotal that a move towards integrating climate-friendly measures be taken as a way to face the climate change challenges head-on. Hence, ignorance of climate issues is no longer an option.