Integrating Climate Risk into Basel III: Evidence from Indian Commercial Banks and a Proposed Climate-Adjusted Basel Risk Framework (CABRF)
DOI:
https://doi.org/10.66635/ezh6hn09Keywords:
climate risk, banking stability, Basel III, capital adequacy, climate finance, prudential regulation, Indian commercial banks, climate-adjusted risk-weighted assets, CABRFAbstract
Climate change is increasingly recognised as a financial stability concern because physical hazards and the transition to a low-carbon economy can weaken borrowers, reduce collateral values, increase credit losses and alter banks’ capital requirements. This study examines whether bank-specific climate exposure is associated with capital adequacy in Indian commercial banks and develops a Climate-Adjusted Basel Risk Framework (CABRF) that translates observed exposure into a prudential capital overlay. The study uses a hand-collected panel of ten major Indian public- and private-sector commercial banks for FY2015–FY2024. The analysis combines bank-level Basel III indicators with sectoral lending, climate-governance and green-finance disclosure measures and national physical-hazard indicators. A Climate Risk Exposure Index (CREI) is constructed as the interaction of a Climate Hazard Index (CHI) and a Bank Exposure Score (BES). Fixed-effects, random-effects and pooled estimations are complemented by robustness specifications. The preferred fixed-effects model reports a negative and statistically significant coefficient for CREI (−2.42), while the decomposition indicates that BES, rather than the year-common CHI, is the principal driver of the association. The results also indicate that the relationship is more evident for the total capital ratio than for CET1. Based on these findings, CABRF is proposed as a supervisory overlay under Pillar II rather than as a replacement for Basel III Pillar I requirements. The framework adjusts risk-weighted assets according to observed climate exposure and produces a Climate-Adjusted Capital Adequacy Ratio. The paper contributes to the emerging literature on climate-related prudential regulation by linking bank-level empirical evidence to an operational capital framework for an emerging-market banking system.
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