Compliance by financial institutions with ESG requirements for credit decisions, and disclosures has become increasingly prevalent over the last two decades. While some of these requirements are imposed via legislation, others have been voluntarily adopted by financial institutions. Project finance is central to the development of ESG standards.

In the case of India, the Securities Exchange Board of India has become the primary source of ESG requirements for financial institutions, the primary source is the Securities Exchange Board of India. The Reserve Bank of India currently does not mandate that lending decisions take into account ESG risks. In this regard, the RBI’s main tool is the ‘Priority Sector Lending’ requirement, which was expanded in the year 2015 to include renewable energy and social infrastructure.

As a first step, this study documents the ESG compliance landscape of financial institutions in India. It reviews academic literature studying ESG compliance and disclosure by Indian financial institutions. Experience from China and Bangladesh, including literature reviewing the effectiveness of mandatory ESG requirements is drawn upon. The practices being followed by the Asian Infrastructure Investment Bank and requirements under the Equator Principles will also be discussed.

This exercise is being undertaken as the Union Budget for 2021-22 announced the creation of a new Development Finance Institution for India (DFI). The DFI is expected to reduce the infrastructure funding gap and lead the way in developing superior risk management practices for infrastructure finance in India. Historically, weakness in risk assessment and asset-liability mismatch in project finance, led to the presence of significant non-performing assets on the books of the financial institutions. It is therefore imperative that ESG risks be better understood in project finance.

The author suggests that mandatory ESG requirements for project finance are imperative. This exercise will require investment of significant resources and time. The RBI has to build significant skills in this area not only within itself but also across the financial sector as a whole.

Read the full report here: Creating a better Development Finance Institution for India- Report by Praachi Misra

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