20 November 2024

ECB's Elderson: Taking account of nature, naturally

I will outline how the relevance of nature is being confirmed by incoming research and how the European Central Bank (ECB) is acting on this to deliver on its mandate of maintaining price stability and preserving the safety and soundness of banks.

I fully subscribe to the theme of today’s forum, given how vitally important it is to “innovate in nature”. Especially because in many ways nature is still not accounted for in policies, regulation and risk management, but it should be, considering its vital importance for the economy – including the financial system.

A thriving natural environment provides many benefits that sustain human well-being and the global economy. Think of fertile soils, pollination, timber, fishing stocks, clean water and clean air. Unfortunately, intensive land use, climate change, pollution, overexploitation and other human pressures are rapidly and seriously damaging our natural resources. The Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services already sounded the alarm back in 2019, shortly before the outbreak of the pandemic.^[1] The degradation of nature is primarily caused by human activity and is being made worse by global heating. In addition to the depletion of non-renewable resources, natural inputs to the economy that are renewable are also increasingly being degraded. Scientists have calculated that humanity is using natural resources 1.7 times faster than ecosystems can regenerate them – in other words, we are consuming resources equivalent to 1.7 planet Earths.

This nature loss poses a serious risk to humanity as it threatens vital areas, such as the supply of food and medicine. Such threats are also existential for the economy and the financial system, as our economy cannot exist without nature.^[2] One of the papers presented at the annual ECB Forum on Central Banking in Sintra, Portugal, in July of this year shows how biodiversity loss can cause losses to economic output while at the same time decreasing the resilience of that output to future biodiversity losses.^[3] However, in practice, at least thus far, the contribution of the inputs nature provides to the economy is rarely measured directly in statistics like GDP.

Central banks and supervisors like the ECB need to gain a better understanding of just how vulnerable the economy and the financial system are to nature degradation. We need to incorporate nature into the analysis of the drivers of economic development and the assessment of future productive capacity.^[4] Degradation of nature can impair production processes and consequently weaken the creditworthiness of many companies, which might in turn impair loans extended by banks.

How nature affects the economy

As is the case with climate change, nature affects companies and banks via two main channels: physical risks and transition risks. Physical risks may be acute risks, such as increasingly severe natural disasters, or chronic risks, such as dwindling ecosystems. The effects could include falling crop yields owing to a decline in pollinating insects or the degradation of agricultural land. The scarcity of natural products could lead to supply-side shocks for the pharmaceutical industry or make some tourist destinations less attractive.

Nature loss can also amplify the transition risks of banks and their borrowers. Governments are stepping up their efforts to protect the environment: the UN Convention on Biological Diversity set global targets in 2022, including the conservation by 2030 of at least 30% of the world’s lands, inland waters, coastal areas and oceans.^[5] Such government measures could lead to changes in regulation and policy, limiting the exploitation of natural resources or banning certain environmentally harmful products. Technological innovation, new business models and changes in consumer or investor sentiment could also lead to transition risks and transition costs as companies are forced to adapt. Some established business models could disappear, while others might become too expensive and lose market share.

At the ECB, we looked at the dependence on nature of more than 4.2 million individual companies accounting for over €4.2 trillion in corporate loans.^[6] We assessed how dependent companies and banks in the euro area are on the various benefits that humanity obtains from nature – experts call this concept “ecosystem services”. Examples of the services that ecosystems provide are products such as food, drinking water, timber and minerals; protection against natural hazards; and carbon uptake and storage by vegetation....

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