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Growing water risks may aggravate bad loan crisis in Indian banks

New Delhi : The recent issue of widening non-performing assets (NPAs) of Indian banks could get worse in coming years as many lenders have loan exposure to sectors where there are various risks to water resources, a new report by the WWF has warned.

Stating that close to 40 per cent of the gross credit exposure of Indian banks is in sectors where water risks are significant, the WWF report has underlined that the increasing water risks for businesses could lead to significant losses for the country’s banks.

Reeling under a crisis of non-performing loans with close to 10 per cent of gross-advances of the Indian banks facing a risk of non-payment from debtors, these risks can place further liquidity constraints on the already stressed balance sheets of banks in India, noted ‘Hidden Risks and Untapped Opportunities: Water and the Indian Banking Sector’.

The WWF report was published and launched recently along with the Indian Banks’ Association (IBA). It provides evidence for why water presents a material risk for banks in India, particularly how water risks could lead to stranded assets in the power and agriculture sectors, two sectors that account for the highest gross credit exposure of Indian banks.

The NITI Aayog has noted that the current water crisis in the country is its ‘worst ever’. With water being a shared resource, what the country requires is a comprehensive and sustainable water management plan by various stakeholders.

“Water is and will continue to be a critical risk factor for the portfolio of the Indian banks. This report provides a systematic understanding of this risk and a framework that banks can use to effectively assess, measure and mitigate it", said WWF-India Director (Sustainable Business) Bhavna Prasad.

While banks are exposed to the risks of water as lenders to businesses, it also places them in a unique position to influence businesses to proactively handle various water related risks, including using WWF’s Water Risk Filter and enabling flow of capital towards solutions which address such risks.

“Water is central to sustaining a healthy and resilient planet. Banks, by the virtue of their influence as financial intermediaries can play an important role by leveraging commercial capital to help in effective management of freshwater resources. This report outlines steps towards that end", said WWF-India Secretary General and CEO Ravi Singh.

Water related solutions also have the potential to be a source of significant commercial value for banks. The report presents the commercial opportunities for banks in solutions that promote sustainable water management. It also presents a practical guiding framework for banks, based on WWF’s Water Stewardship Ladder, to enable them to start integrating elements of the water thematic within their existing risk and opportunities framework.

"Water-related risks have the potential to limit production, disrupt supply chains, result in asset write-downs, create conflict with other water users and harm corporate reputations, which can lead to financial impacts for businesses and the banks that lend to them", noted report.

Water is a shared resource with applications in agricultural, domestic, industrial and environmental uses. As a growing economy, the demand of freshwater from most of these sectors will increase. It is estimated that by 2030, the total demand of freshwater resources in the country will be twice as much as available supply. These pressures on demand and supply of freshwater could be one among many critical constraining factors for India’s economic growth. Hence, water is inexorably linked to India’s future prosperity.

According to the report, water risks have the potential to create ‘stranded assets’, i.e. assets suffering from unanticipated or premature write-offs, downward revaluations or conversions to liabilities.

In the context of water risks, stranded assets have been referred to as ‘drowned and drying assets.’ Assets in sectors which face high water risks are vulnerable to abrupt and material devaluation, and this is a significant concern for banks. For example, the agriculture and power (thermal and hydropower) sectors, two sectors that face high water risks account for more than 20 per cent of the gross credit exposure of Indian banks.

As lenders, banks have significant stakes in the performance of the businesses they lend to, and share risks that threaten the ability of clients to repay. The financial risks presented by water to businesses are significant, widespread, growing and increasingly evident.

The banks in India have a high level of exposure to water risk through the companies and sectors that make up their lending portfolios. Some sectors constituting the highest exposure of banks are also characterized by stalled investments in unproductive assets and water is a critical factor behind the potential for ‘drowned or drying’ assets, the report said.

"These competing demands on water will also place significant risk to businesses which need water in their operations or along their supply chains. These risks can stem from the operation of the company or from the location the company operates in. These risks then have the potential to materialize into financial risks for the banks and financial institutions that have exposure to these businesses", the report said.

However, water also represents an untapped opportunity for banks, if understood and managed well. With significant investments in water required now and in the future, water can also be a source of sustainable profit for the banking sector.

"Water issues also present opportunities for banks and investors to invest in technologies and businesses that help improve sustainable water resource management while generating attractive financial returns. It is estimated that to keep pace with the current levels of GDP growth, a global cumulative capital investment of $57 trillion will be needed in infrastructure between 2013 and 2030, including $11.7 trillion in water infrastructure. To put it in perspective, the investment required in water is higher than telecom ($9.5 trillion) and comparable to power ($12.2 trillion)", the report added.

Given the investment needs, commercial finance will be important to ensure sustained investments in the sector, and also in influencing the improvement of operational and financial standards in the sector. However, commercial finance cannot be a standalone solution for financing needs in the sector and it needs to supplement the existing public finance structures to unlock increased investments in the sector.

The report has suggested some actions that the banks can take to reduce water related portfolio risks and harness greater commercial value from water. These include integration of water within the core strategic considerations of the bank through governance structures, policies, standards and processes that influence internal decision-making within the bank; strengthening capacity to recognize, measure and act on water risk & response – including ESG understanding and data, in order to evaluate portfolio companies and the value chains of these companies; and tapping into the ever-increasing potential opportunities in water by proactively supporting companies/assets/technologies that seek to reduce water related risks and developing water-specific offerings (e.g. water mutual funds, water risk credit-adjustments etc).

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