Green lending helps banks improve financial stability: IIM research

Banks that have a greater proportion of green loans experience long-term improvements in financial stability, according to research by the Indian Institute of Management (IIM), Lucknow.

The study published in the prestigious Finance Research Letters journal found that expansion of non-carbon intensive lending can improve the core of loan portfolios of Indian banks.

The findings underscore the strategic importance of sustainable lending in the Indian banking system.

A green loan is a form of financing that enables borrowers to use the proceeds to exclusively fund projects that make a substantial contribution to an environmental objective.

According to Vikas Srivastava, ONGC Chair Professor, IIM Lucknow, despite global initiatives to create uniform frameworks for green lending, there are significant gaps in providing incentives, particularly in developing economies such as India.

"Most Indian banks are heavily dependent on lending to carbon-intensive industries as there is no clear taxonomy to identify and promote green assets. Our study addresses this gap by designing a framework to identify non-carbon-intensive sectors and assessing their impact on the quality of the bank's loan portfolio," Srivastava said.

"Additionally, for the first time, the study has ranked Indian banks based on the sustainability of their credit portfolios, with a specific focus on non-carbon-intensive loans. This evaluation provides valuable insights for shaping future credit allocation strategies, helping banks balance financial stability with sustainable growth,” he added.

The study also emphasizes that Indian banks can act as catalysts in transforming the economy towards a low-carbon economy. By increasing lending to non-carbon-intensive sectors, banks can reduce default risks, align with global sustainability goals, and contribute to long-term economic resilience.

"Our attempt at standardization of green loan taxonomy and finding that a critical mass of green asset lending is required for an optimized credit portfolio is a critical insight that can help the top management of banks to focus on this asset class as an opportunity to build sustained lending competence across their credit teams," said Sowmya Subramaniam, Associate Professor, Finance and Accounting, IIM Lucknow.

"Our findings may help regulators to perhaps come out with appropriate regulatory nudges for banks. An optimized bank credit portfolio will go a long way to improve the competitiveness of the Indian banking sector," she added.

The researchers noted that considering the high exposure to risks due to climate change and carbon-intensive industries, Indian banks must proactively modify and diversify credit portfolios.

"While non-carbon-intensive lending offers a strategic opportunity to ensure sustainability, without any regulatory push, banks are suspected to face hurdles in adopting green lending practices. This highlights the urgent need for policy interventions to achieve sustainable finance," said Vidya Mahadevan, Research Scholar, IIM Lucknow.

"Our study provides a data-driven framework for integrating green finance into mainstream banking operations, ensuring that Indian banks remain financially strong while contributing to a more sustainable future," Mahadevan added.

(PTI)