The exposure of the banking sector has so far been very limited to alternative energy sources

The move to a net-zero carbon emissions target could affect the incomes of industries that indirectly use fossil fuels, and therefore their interest coverage ratio (ICR). This, in turn, could affect the gross non-performing assets (NPA) ratios of banks with exposure to such industries, the Reserve Bank of India (RBI) said in a report in its March 2022 bulletin. The gross non-performing assets (GNPA) ratio of such industries may be sensitive to the transition to green energy, and their impact on the overall banking system should be closely monitored,” the report said.

Virtually all sectors of the economy are indirectly exposed to fossil fuels through the use of electricity, gasoline, diesel or coal in their production processes. In India, 62.2% of the total electricity generated comes from fossil fuels, with the rest coming from renewable or non-fossil sources, according to the report titled “Green Transition Risks to Indian Banks.”

The sectors with a high input intensity of fossil fuels due to indirect exposure are cement, base metals, paper products and textiles. “We believe that a transition to green energy and shifts in the input mix could put some pressure on input costs in these sectors in the near term,” the RBI said in the report.

Depending on market structures and pricing power, this cost increase could be passed on to end users or borne by the companies. In the second scenario, the earnings before interest, taxes and amortization (EBITA) of the representative companies could take a hit, leading to a deterioration in the usefulness of loans. This, in turn, could lead to an increase in the GNPA ratio of such sectors, the RBI said.

gIn general, it is necessary to closely monitor all such industries with low ICR, high GNPA ratio and high energy input intensity to avoid spillover into the broader banking sector,” the report said.

Three sectors with direct exposure to fossil fuels – electricity, chemicals and cars – account for about 24% of lending to the total industrial sector. At the same time, they represent only 10% of total outstanding non-retail bank credit, implying limited spillover to the banking system.

Sectors such as electricity and base metals absorb a significant proportion of total credit disbursed by the banking sector, but have moderate exposure to fossil fuels. In turn, sectors such as cement manufacturing have high exposure to fossil fuels, but their credit stocks are small. “So no major vulnerabilities in the banking sector are expected from any disruptions in sectors highly exposed to fossil fuels,” the central bank said.

As of March 2020, the share of electricity generation in outstanding bank credit was 7.5% and 4% for public sector and private sector banks respectively. On the other hand, the share of bank credit to the auto industry in the same period was 0.8% and 2% for PSBs and private banks respectively.

The exposure of the banking sector has so far been very limited to alternative energy sources. At the level of the whole of India, only about 8% of bank credit deployed in the electricity sector goes to non-conventional energy production. The share of non-conventional energy in utility lending is higher for private banks at 14.8% and 5.2% for PSBs, the report said.

This post RBI March Bulletin: Green Energy Transition Could Affect Banks’ NPAs

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