Posted on 12 July 2021
Why central bankers need to take action on biodiversity risk
The unprecedented rate of biodiversity loss – exacerbated by and contributing to climate change – is undermining key ecosystem services and natural resources on which the economic system depends, fueling economic vulnerabilities and risks. Just as central banks have begun to consider climate change risks as falling within their mandates, the transmission of nature-related risks from the real economy to the financial sector should be a major concern for central banks and financial supervisors.
Similarly to climate-related risks, nature-related risks can be characterized as comprising:
- Physical risks, from the potential for reductions in the quantity and quality of services provided by natural systems;
- Transition risk, arising from actions or changes which occur to combat or reduce nature and biodiversity loss; and
- Liability risks, from litigation against entities held responsible for biodiversity loss and resulting damages.
Biodiversity loss also poses systemic environmental risks, with non-linear consequences and tipping points. These risks flow through from the macro-economy to the financial sector – this report offers seven case studies setting out how biodiversity loss creates or contributes to economic impacts that have the potential for financial sector implications. As well as facing risks from biodiversity loss, the finance sector impacts biodiversity through its lending and investments. The sector generally fails to measure, manage and reduce these impacts. Moreover, as central banks increasingly participate in financial markets through their adoption of unconventional monetary policies, they risk adding to these negative impacts.
Making the case for action
This report sets out the case for central banks to consider these risks and impacts. Critically, they need to assume that environmental degradation (including biodiversity loss) poses financial risk unless it can be shown not to be the case. They also need to be proactive, forward-looking and take preventative measures to mitigate nature related-financial risk.
The Convention on Biological Diversity already calls for signatories to integrate conservation and the sustainable use of biological diversity into their policies. Their efforts, here, are supported by internationally agreed financial standards, such as the Basel III capital adequacy rules for banks and the Insurance Capital Standard, which could be applied to biodiversity-related financial risk. In addition, central banks are building the expertise and capacity to manage nature-related financial risk. Four pillars are important in this endeavour. Central banks and financial supervisors must not wait but immediately act to:
- Integrate environmental risk into macro- and microprudential supervision;
- Address environmental risk on their own balance sheets,
- Require enhanced disclosure from the financial sector, as is envisaged by the work of the Taskforce on Naturerelated Financial Disclosures; and
- Prepare the adaptation of international financial standard to properly take into account those new cross cutting dimensions into traditional financial risks management, ensuring the necessary coordination and convergence of practices.