Industry

NGFS Warns on Nature-related Risks to Financial Stability

Physical and transition risks linked to biodiversity loss will be harder for the financial industry to assess than for climate change, according to central banks.

The NGFS (Network for Greening the Financial System) has warned that a failure to account for, mitigate, and adapt to nature-related risks can threaten financial stability.

In a statement issued on Thursday (24 March), the NGFS said nature-related risks, including those associated with biodiversity loss, could have “significant macroeconomic implications” and should be considered by central banks and supervisors for the fulfilment of their mandates.

The statement noted that the extent and severity of the physical and transition risks linked to biodiversity loss are “more difficult to assess than for climate change”.

Biodiversity loss and other environmental degradation are driven by several factors, while climate change is largely determined by GHG emissions, the NGFS said. “Assessment of the impacts of biodiversity loss is also more complicated due to the complexity of ecosystems and of the processes involved as well as to the non-linearity and irreversibility of some of these developments.”

The NGFS also highlighted challenges related to the assessment of the economic value of ecosystem services, emphasising scientific evidence that nature loss could present “potentially significant risks with material economic and financial consequences”.

The statement said central banks, financial supervisors and financial institutions need to start building a “scientifically-grounded analytical framework” to assess the interactions between nature, the macroeconomy and the financial system.

They should also begin work on bridging the data gaps that will emerge from such a framework, with a view to using the new framework and associated datasets to align policies with environmental sustainability and inform the assessment of nature-related financial risks.

The statement follows the finalisation of work on the topic of ‘biodiversity and financial stability’ by an NGFS-INSPIRE joint study group. The group was established in April 2021 to develop a research-based approach to how central banks and supervisory authorities can fulfil their mandates in the context of biodiversity loss.

The study group published a vision paper in June 2021, setting out the links between biodiversity loss and macroeconomic and financial systems; and an interim report in October 2021, outlining the challenges of assessing such links and providing potential ways forward for central banks and financial supervisors.

The latest findings are presented in a third report, available here, which analyses different approaches to the design of nature-related scenarios, considers gaps in knowledge, sets out a research agenda, and identifies near-term policy options.

It makes five recommendations for action by central bankers and financial supervisors to help them fulfil their mandates in the face of biodiversity loss:

  • recognise biodiversity loss as a potential source of economic and financial risk and commit to developing a response strategy to maintain financial and price stability
  • build the skills and capacity among central bank and supervisory staff as well as market participants to analyse and address biodiversity-related financial risks
  • assess the degree to which financial systems are exposed to biodiversity loss, by, for example, conducting assessments of impact and dependency, developing biodiversity-related scenario analysis and stress-tests
  • explore options for supervisory expectations for financial institutions’ governance, risk management, strategy, disclosure and financial conduct in relation to biodiversity-related financial risks and opportunities
  • help build the necessary financial architecture for mobilising investment for a biodiversity-positive economy, including by considering how central banks’ monetary policy operations and non-monetary policy portfolio management should be conducted in the context of biodiversity loss

In a statement, the NGFS welcomed the policy recommendations made by the study group, pledging to create a task force to mainstream the consideration of nature-related risks across its activities in the coming years.

“The task force will act as an incubator that explores, develops, and harmonises relevant nature-related considerations and efforts in collaboration with the NGFS workstreams, expert networks, and members,” the NGFS said.

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