09 June 2023

ECB's Elderson: The economy and banks need nature to survive

Humanity needs nature to survive, and so do the economy and banks. The more species become extinct, the less diverse are the ecosystems on which we rely. This presents a growing financial risk that cannot be ignored, warns Frank Elderson

A thriving nature 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 degrading our natural resources.^[1] This nature loss poses a serious risk to humanity as it threatens vital areas, such as the supply of food and medicines. Such threats are also existential for the economy and the financial system, as our economy cannot exist without nature.^[2] Degradation of nature can impair production processes and consequently weaken the creditworthiness of many companies. Central banks and supervisors therefore need to understand how vulnerable the economy and the financial system are to this degradation. This is why the ECB has started looking at the dependence on nature of more than 4.2 million individual companies accounting for over €4.2 trillion in corporate loans.

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.^[3] Examples of such services are the products that we obtain from ecosystems such as food, drinking water, timber and minerals; protection against natural hazards; or carbon uptake and storage by vegetation. Our preliminary assessment showed that nearly 75 per cent of all bank loans in the euro area are to companies that are highly dependent on at least one ecosystem service. This means that these companies depend on ecosystem services to continue producing their goods or providing their services.^[4] If nature degradation continues as now, these companies will suffer and banks’ credit portfolios will become riskier.

How nature-related risks lead to financial risks

There are two main channels via which nature affects companies and banks: 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. Scarcity of nature’s products could lead to supply side shocks for the pharmaceutical industry or to destinations becoming less attractive for tourism.

Nature loss can also amplify the transition risks of banks and their borrowers. Governments are increasing their efforts to protect the environment: the UN Convention on Biological Diversity set global targets in 2022, including the conservation of at least 30 per cent 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 products that trigger degradation. 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 older business models could disappear, while others might become too expensive and lose market share.

In a landmark study, De Nederlandsche Bank found that Dutch financial institutions alone have €510 billion in exposures to biodiversity risks^[6]. In a similar study, the Banque de France found that 42 per cent of the value of securities portfolios held by French financial institutions consists of securities issued by companies dependent on at least one ecosystem service.^[7]...

 more at ECB

© ECB - European Central Bank