Central banks and biodiversity

While the financial world has been interested in climate change for many years, the interest in biodiversity is more recent. Indeed, studies to assess the dependence of companies and the financial system on biodiversity only began about ten years ago. One study shows that the proportion of central bank speeches mentioning climate change was still 10 times higher than those mentioning biodiversity in 2023 despite a very sharp increase in the latter since 2017. 

It is interesting to see how central banks and financial supervisors have taken up this subject and what role they can play in better understanding the risks related to biodiversity on economic and financial systems.

Financial risks from the degradation of nature

Nature and biodiversity provide essential services to many human activities, called ecosystem services: provisioning, regulating or intangible services. At the same time, some economic activities harm nature.

The degradation of biodiversity therefore generates two types of risk: a physical risk linked to the dependence of an activity on ecosystem services and a transition risk or footprint risk for activities that will have to adapt to limit their negative impact on nature.

The relationship between biodiversity and financial institutions is indirect and two-way. The deterioration of natural and ecosystem services has an impact on the output of many sectors and by extension on the financial institutions that finance them. This can generate a credit risk and a risk on the value of banks' assets. In addition, financial institutions finance companies that have negative impacts on nature.

The more the degradation of nature intensifies, the greater its impact on the economy is likely to be. These risks can accumulate and amplify each other, thereby threatening financial stability.

The difficulties of assessing risks related to nature

The assessment of risks related to nature comes up against many methodological difficulties: complexity of ecosystems, absence of a single measure of biodiversity, absence of fundamental value of biodiversity, non-linearity of ecosystems, limited substitutability of natural capital which could lead to cascading risks, multiple scenarios on the evolution of biodiversity, uncertainty on the shocks which could affect it as well as the channels of contagion…. 

Then, it is complex to assess the activity of a company and its interactions with ecosystems by integrating its entire value chain.

Nature-related financial disclosure practices are at an earlier stage than climate-related ones. But the Taskforce on Nature-related Financial Disclosures (TNFD) published recommendations in September 2023 to help identify, analyse, manage and disclose such information. It should play a coordinating role like the Taskforce on Climate Financial Disclosures (TCFD) did for climate data.

Central banks’ understanding of nature-related risks

The concept of double materiality leads to jointly assessing the vulnerability of financial institutions to biodiversity-related risks and their contribution to these risks. The more the financial system contributes to degrading biodiversity, the more it is exposed to physical risks (if nothing is done) and transition risks (if measures are taken). 

The Dutch central bank was the first central bank to propose a framework for assessing nature-related financial risks in 2020, which led it to define an indicator of sensitivity to the degradation of ecosystem services (EDSI).

A key element of the EDSI framework is the integration of multiple data sources and tools: the ENCORE database was used to measure the dependence of each economic sector on ecosystem services, EXIOBASE as a supply chain map and ND-GAIN to assess the extent of degradation of ecosystem services. The combination of these data resulted in a vulnerability factor that measures how nature degradation depreciates the assets of companies that depend on nature and increases the probability of default of these companies. 

The study reveals that Dutch financial institutions are exposed to companies with a high or very high dependence on one or more ecosystem services to the tune of €510 billion, or 36% of the portfolios examined. The biodiversity footprint of Dutch financial institutions is comparable to the loss of more than 58,000 km² of wilderness, which is an area more than 1.7 times the land area of the Netherlands.
The Dutch central bank conducted a new study in 2023 which aims to be more forward-looking since it includes 5 scenarios for the evolution of biodiversity: 4 transition scenarios and a risk scenario.

In 2021, the Banque de France conducted a first assessment of biodiversity risks for the French financial system. It showed that 42% of the portfolio of securities held by French financial institutions were issued by companies that depend heavily or very heavily on at least one ecosystem service. The main dependence on ecosystem services concerns the supply of water, which is essential for production processes in the primary and secondary sectors.

It also showed that the economic activities financed by French financial institutions have an impact comparable to the loss of 130,000 km² of pristine nature, which corresponds to the artificialization of a quarter of the surface area of metropolitan France. The measures that will be taken to protect nature will therefore have a significant impact on the activity of many economic players.
The NGFS published a first version of its conceptual framework on nature-related financial risks in September 2023 and then an enriched version in July 2024. It includes a report that describes the general framework of nature-related risks and a second report that focuses more specifically on the risk of nature-related litigation. These are constantly progressing. 

This work has two objectives: first, to provide the financial system with a common language on nature-related risks and second, to guide the action of central banks and financial supervisors.
François Villeroy de Galhau believed that "through this work, the NGFS has laid the foundations that will allow central banks and supervisors to begin to operationally take into account the degradation of nature in their mandate."

A very recent European study from December 2024 carries out a first stress test of the European financial sector to biodiversity-related transition risk. It shows that the direct exposure of the European financial system to biodiversity-related transition risks is moderate and lower than that to climate-related transition risks. 

Outside Europe, central banks devote little research to biodiversity. However, in Asia, the Central Bank of Malaysia has been a pioneer in studying the relationships between the financial system and nature-related risks. It published a report in cooperation with the World Bank entitled "A Study of Nature-Related Financial Risks in Malaysia" in March 2022. It shows that around 54% of the commercial loan portfolio of Malaysian banks could be exposed to physical risk, being heavily or very heavily dependent on ecosystem services. At the same time, the banks' loan portfolio is exposed to significant transition risk. If the government were to implement nature conservation policies or if consumer preferences were to change, 87% of Malaysian banks’ commercial loan portfolio could currently be exposed to sectors that have a high impact on ecosystem services.

The Financial Stability Board, which coordinates the work of financial authorities and supervisors internationally, conducted a stocktaking exercise on nature-related risks in July 2024 and proposed a path forward for financial supervision and regulation. The assessment shows that authorities have very different levels of understanding of this issue. Some prefer to focus on climate-related risks and are very reluctant to understand nature-related risks.

The tracks for the future

As we have just seen, the understanding of nature-related risks and their interactions with financial institutions is carried out with reference to the financial stability mandate of central banks. In this area, Europe and more particularly the ECB are at the forefront in terms of research. The ECB has thus made nature one of the priority axes of its climate-nature plan for 2024-2025.

The work of central banks on biodiversity has first consisted of deepening knowledge of the financial risks linked to the loss of biodiversity, then of ensuring that banks integrate the management of this risk into their strategy and of requiring, as supervisors, that banks provide better reporting on nature-related risks. It should be noted that significant progress has been made in terms of the availability of nature-related data in recent years, but that major challenges remain in improving the assessment of financial risks related to biodiversity: biodiversity evolution scenarios, biodiversity risk scenarios, risk transmission between sectors, scenarios for aligning financial institutions with nature preservation and restoration objectives, etc. Ultimately, with biodiversity, central banks are adopting a similar path to the one they took with climate change. Their objective is clear, but they will probably still be feeling their way for a while. In short, “biodiversity finance” is only just beginning.