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

Almost all the sectors in the economy are indirectly exposed to fossil fuel by virtue of using electricity, petrol, diesel or coal in their production processes. In India, 62.2% of the total electricity generated is sourced from fossil fuel, with the rest coming from renewable or non-fossil sources, according to the report, titled ‘Green Transition Risks to Indian Banks’.

The sectors which have high input intensities of fossil fuel through indirect exposure are cement, basic metals, paper products and textiles. “We assume that because of a transition to green energy and shifts in input mix, there could be some pressure on input costs in these sectors in the short-term,” the RBI said in the report.

Depending on the market structures and pricing power, this increase in cost could be transferred to end-users or could be borne by the firms. In the second scenario, the earnings before interest, taxes and amortisation (EBITA) of the representative firms could take a hit, leading to worsening of loan serviceability. This, in turn, could lead to an increase in GNPA ratio of such sectors, the RBI said.

gOn the whole, there is a need to closely monitor all such industries that have low ICR, high GNPA ratio and high energy input intensity to prevent spillover to the broader banking sector,” the report said.

Three sectors with direct exposure to fossil fuels – electricity, chemicals and automobiles – account for around 24% of credit to the overall industrial sector. At the same time, they constitute only 10% of total outstanding non-retail bank credit, which implies a limited spillover to the banking system.

Sectors like electricity and basic metals absorb a significant proportion of total credit disbursed by the banking sector but have moderate exposures to fossil fuel. Sectors like cement production in turn have large exposure to fossil fuel, but their credit shares are small. “So, large vulnerabilities are not expected to emerge in the banking sector from disruptions, if any, in the sectors that are highly exposed to fossil fuel,” the central bank said.

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

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