Traditionally, credit decisions in India have involved assessments of financial statements, collateral requirements, and a healthy repayment history. While these remain critical, a structural shift is underway that is redefining how lenders assess risk.
Environmental, Social, and Governance (ESG) data is no longer just a consideration. It is fast becoming essential to evaluate the creditworthiness of the borrowers. While ESG was considered a “good to have” metric till very recently, it is soon evolving into a “must have,” driven by regulatory guidance, investor expectations, and real-world risk exposure.
The push from regulation and green finance
The RBI Framework for Acceptance of Green Deposits, effective from June 1, 2023, formalises how banks and NBFCs raise and utilise “green” funds. Let’s understand these terms in detail. “Green Deposits” are the liability-side instrument for raising funds. RBI allows banks to raise green deposits to finance projects like renewable energy, green buildings, and sustainable water management, ensuring funds are channeled into sustainable activities.
On the other hand, the Green Credit Program (GCP) is not related to lending but is a separate market-based mechanism launched by the Indian government to incentivise voluntary environmental actions. While the RBI framework focuses on Green Deposits (raising capital), it is part of a broader ecosystem that is the Green Finance Ecosystem. Thus, Green deposits are the “sourcing” side, while the actual lending/investment is termed Green Finance.
The framework also clarifies that the projects financed through green deposits can be classified under Priority Sector Lending if they meet specified PSL criteria, thus acting as a form of “credit” incentive for banks to fund green projects. The Reserve Bank of India (RBI) has also encouraged financial institutions to integrate climate-related financial risks into their risk management frameworks.
Globally, financial institutions are recognising that non-financial risks, such as climate exposure, labor practices, and governance failures, can materially impact a borrower’s ability to repay. Globally, trade finance has emerged as an important sub-segment within sustainable lending.
The International Chamber of Commerce (ICC) has issued ‘Principles for Sustainable Trade Finance’ for voluntary, market-led adoption, reflecting growing recognition of the role of trade finance in supporting sustainable supply chains in October 2024. India is following this trajectory, albeit with its own nuances.
From backward-looking metrics to future risk signals
Traditional financial metrics are backward-looking; they capture what has already happened to predict future possibilities of default. ESG indicators, on the other hand, help anticipate future disruptions, be it regulatory penalties for environmental violations, reputational damage, or supply chain breakdowns due to poor social practices.
In this context, ESG is no longer about values alone; it is about risk intelligence. India’s regulatory work in the recent past has worked toward building an ecosystem that is resilient by reinforcing this transition. While the regulatory framework is still evolving, the direction is clear. As per the RBI’s framework, lenders are expected to integrate ESG considerations into their risk assessment frameworks as well. This guidance is not just for compliance, but it is also to mitigate risk and build systemic resilience.
The lending industry is now acknowledging that climate risks can translate into credit risks, especially in agriculture, infrastructure, and manufacturing. And by factoring in ESG data, regulators are effectively future-proofing the financial system. As guidelines become more structured, ESG data will move to a core requirement in loan underwriting very soon.
What this means for MSMEs and the road ahead
MSMEs are the backbone of the Indian economy. They drive economic growth through production and employment generation. Yes, due to cost pressures, they often lack the resources to measure and report ESG metrics. While lenders now need ESG data to make informed decisions, a large segment of MSMEs, especially Micro and Small enterprises, are not equipped to provide it.
The solution is to support them with scalable ESG evaluation models customised for MSMEs, as well as standardised reporting formats, and digital data capture can bridge this gap in the near future. The MSMEs that adapt early will gain a competitive edge, better access to credit, potentially lower borrowing costs, and stronger relationships with lenders. However, those who ignore ESG may find themselves increasingly facing hurdles to access credit at affordable rates.
As ESG gains critical importance, there are concerns around “greenwashing”. Greenwashing is defined as the practice of overstating or misrepresenting sustainability credentials. This can be a critical risk for lenders. Decisions based on inaccurate ESG data can lead to misplaced risk and reputational damage. To mitigate this, banks and financial institutions will begin demanding verified, auditable ESG data, which will lead to technology-driven data capture and standardised scoring mechanisms becoming essential.
In the near future, the question will no longer be whether ESG data is required for credit decisions. The real question will be how robust, reliable, and actionable that data is. In this evolving landscape of Indian lending, ESG is not just an add-on; it is becoming the foundation of every high-impact, forward-looking decision.
For lenders, this means rethinking underwriting models. For borrowers, especially MSMEs, it means building the capability to measure and communicate ESG performance. And for the broader financial ecosystem, it means embracing transparency and accountability at a deeper level.
Disclaimer: The information provided in this article is for informational purposes only and does not constitute financial, legal, or professional advice. While every effort has been made to ensure accuracy, readers should verify details independently and consult relevant professionals before making financial decisions. The views expressed are based on current industry trends and regulatory frameworks, which may change over time. Neither the author nor the publisher is responsible for any decisions based on this content.
Sachin Seth, Regional Managing Director, CRIF India & South Asia