Green loan expansion can boost loan portfolios of Indian banks: IIM study

Expanding non-carbon-intensive lending can enhance the core of Indian banks' loan portfolios, according to a study by the Indian Institute of Management (IIM) Lucknow Faculty Research.

 

The study provides compelling evidence that banks with a greater proportion of green loans experience long-term improvements in financial stability, underscoring the strategic importance of sustainable lending in India's banking system.

 

The findings have been published in Finance Research Letters, a leading academic journal. Despite global efforts to establish uniform frameworks for green lending, significant gaps remain in providing incentives, particularly in developing economies such as India. Most Indian banks remain heavily reliant on lending to carbon-intensive industries due to the absence of a clear taxonomy for identifying and promoting green assets.

   

The IIM Lucknow study seeks to address this gap by designing a framework to identify non-carbon-intensive sectors and assess their impact on loan portfolio quality.

 

For the first time, the study ranks Indian banks based on the sustainability of their credit portfolios, focusing on non-carbon-intensive loans. This evaluation provides valuable insights for shaping future credit allocation strategies, helping banks balance financial stability with sustainable growth.

 

The study also highlights that Indian banks can play a pivotal role in transitioning to a low-carbon economy. By increasing lending to non-carbon-intensive sectors, banks can reduce default risks, align with global sustainability goals, and enhance long-term economic resilience.

 

“Our attempt to standardise green loan taxonomy and demonstrate that a critical mass of green asset lending is required for an optimised credit portfolio provides a key insight that can help banks' top management focus on this asset class as an opportunity to build sustained lending competencies. Our findings may also help regulators introduce appropriate policy incentives for banks. An optimised credit portfolio will significantly improve the competitiveness of India’s banking sector,” the authors stated.

 

The study is co-authored by Vikas Srivastava, ONGC Chair Professor; Sowmya Subramaniam, associate professor, finance and accounting; and Vidya Mahadevan, research scholar at IIM Lucknow.

 

Green lending improves loan portfolio quality 

The research defines a non-linear, inverted U-shaped relationship between non-carbon-intensive lending and non-performing loans (NPLs). While the benefits may not be immediately apparent at lower levels of green lending, once a critical threshold is reached, the overall credit quality of banks improves significantly.

 

Need for standardised green taxonomy and regulatory support 

Despite global efforts to define green investments, India lacks a robust regulatory framework and clear green taxonomy parameters to guide banks in sustainable lending practices. The study proposes a structured classification framework to categorise economic sectors based on their carbon intensity, helping banks implement appropriate credit interventions.

 

Given the growing risks posed by climate change and the banking sector’s high exposure to carbon-intensive industries, Indian banks must proactively diversify their credit portfolios. While non-carbon-intensive lending presents a strategic opportunity for financial sustainability, the lack of regulatory incentives may hinder widespread adoption. This underscores the urgent need for policy interventions to support sustainable finance.

 

The IIM Lucknow 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.