Lender’s responsibility towards sustainable development

by | Dec 8, 2015 | Learning Module 4, Topic 8: NPA's in the Banking sector in India

The enactment of the Companies Act, 2013 and its stress on Corporate Social

Responsibility (CSR) has changed the way India Inc. once thought about philanthropy. Modern

day corporations are now expected (indeed required) to participate more and more in the State’s

drive of fostering social welfare. With increasing focus on what companies should or should not

do in terms of social and environmental impact and the larger welfare of the community in which

they operate, the role and responsibility of lenders has been rather under-emphasized.

As service organizations, banks and Financial Institutions (hereafter, FIs) are not direct

polluters of the environment. However, banks can contribute indirectly when they finance

projects that have the potential to cause environmental damage. Indian regulations require project

developers to undertake a thorough analysis of the impact of the proposed project culminating in

an Environment Impact Assessment (EIA) Report. This document is a pre-requisite for obtaining

clearance from regulatory authorities and any financing.  The EIA is a comprehensive picture of

the perceived environmental impact of the project with details regarding items such as water, air

and noise pollution, displacement of local population, soil erosion, disruption of water ecology,

loss of aquatic wildlife. The EIA must be made available to banks and FIs and is an integral part

of convincing them about the feasibility and long-term viability of the project at hand.

It appears that , despite the availability of the EIA with Indian banks and FIs, they are not

adequately discharging their ‘vetting’ function. One case that illustrates the complexity is the

Loharinag Pala hydro power project which was scrapped after three years of work. This

ambitious project (which represented the NTPC’s first foray into hydro-electricity) on the river

Bhagirati in Uttarakashi, had an expected project cost of nearly 3,000 Crores. As required, an EIA

was prepared, necessary clearances obtained and work on the Loharinag Pala began.

Interestingly, the EIA had clearly spelt out that the developer believed the environmental damage

from the project to be of a ‘permanent’ nature, more specifically, in the form of loss of

agricultural and forest land, disruption of aquatic life in the Bhagirati, resettlement of households

in the area and reduced river flows, resulting in a deterioration in river quality. However, after

three years and expenditure running in millions of rupees, social and religious activists demanded

scrapping of the project. Their argument was that the Loharinag will end up contaminating the

Bhagirati, which is of significant religious importance to Hindus in India, being a tributary of the

sacred river Ganga. After a long-drawn legal battle, the State Government finally decided in favor

of scrapping the project.

Any guesses about losses due to premature termination of the project? Nearly Rs. 600

Crores had already been spent, Rs. 1900 Crores committed and equipment worth Rs. 2,000 Crores

ordered. It must be remembered that this is just one example of how carelessness on the part of a

crucial vetting authority such as the financing bank resulted in significant waste of resources,

time and of course, effort. Needless to say, an event such as this could easily have been averted, if

few hours had been spent on assessing the long-term viability of the lucrative-looking project.

On the global front, things are not that disappointing. Most countries today have both

realized and highlighted the role and responsibility of banks and FIs in ensuring financial

sustainability. One notable example is that of the Equator Principles (EP). The EPs represents a

set of voluntary guidelines designed for assessing, categorizing and managing environmental and

social risks in project financing. These are based on the World Bank and International Finance

Corporation (IFC) policies and guidelines. First announced in 2003, 80 EP Financial institutions

(EP FIs) across 35 countries have adopted these Principles till date. This represents nearly 70

percent of international project finance lending in emerging economies. Banks and FIs who adopt

the EPs commit to the application of extensive care and due-diligence on the social and

environmental front, for project values exceeding US$ 10 million.

As on date, no Indian bank has signed the EPs. In December 2007, an RBI circular

stressed the need for banks to act more responsibly toward sustainable development and also

highlighted the existence of the Equator Principles. In 2013,  IDFC, India’s largest integrated FI

adopted the Equator Principles. However, YES Bank and Infrastructure Leasing and Financial

Services (IL&FS) are the only Indian bank and FI respectively to have signed up the UNEP FI,

which is a global partnership between the UNEP and the financial sector to spread awareness and

sensitivity on sustainability matters. Still, Indian banks seem to be gearing up to the idea of

financial sustainability, thanks to the encouraging attitude of the Reserve Bank of India. Recently

(WHEN?), the Government of India has issued guidelines to banks urging them to ‘Go Green’ by

cutting down on their use of paper, electronic payments and video conferencing, to name a few.

Indian banks, therefore, have been and continue to be the backbone of industrial

development in India. The Indian banking scenario provides a colorful diversity of public-sector

banks, private banks, foreign banks and the like. However, Indian banks have differed largely

among themselves, in terms of their economic performance and ability to deal with bad loans.

Profitability has been an important objective of Indian banks and has, over time, helped them

evolve from outdated bank practices to contemporary automated ways, from making loans under

Government-pressure to choosing their clients diligently and so on. Avoiding non-performing

assets (NPAs) in future has been, and rightly so, a key factor governing the loan decisions of

Indian banks. However, perhaps what they have failed to look at is the fact that mere disbursal of

loans to apparently credit-worthy borrowers for herculean projects is not enough. While banks

may not directly influence the environment or the country’s reservoir of natural resources,

through its lending function (which stands at the heart of its existence), its role in the latter

becomes all the more nuanced. Granting loans for projects that would eventually result in

environmental degradation in any form is not only financially detrimental to the interests of

banks, but also irresponsible behavior. Not only is recovery of credit a painful task in such cases,

banks may have a lot to lose in terms of their reputation. Being associated with projects viewed as

‘unsocial’ or ‘immoral’ serves as a detriment to the public image that banks would like to

So let’s be together in our quest for sustainable development – as individuals, banks and

corporations who have great business ideas. After all, we want to see our children perform

smarter and better than us. This they can do only if we leave some resources at their disposal.