Introduction

Nature is fundamental to human well-being, a healthy planet, and economic prosperity. However, human demands have exceeded the planet’s ability to provide essential services, resulting in the degradation of nature and its diversity at unprecedented rates. Monitored wildlife populations have declined by an average of 69% since 1970, and six of the nine planetary boundaries that maintain Earth’s resilience have already been exceeded. In response, the Kunming-Montreal Global Biodiversity Framework (GBF) was adopted in 2022, aiming to halt and reverse biodiversity loss by 2030. The NGFS acknowledges that nature-related financial risks have significant macroeconomic implications, and failure to account for them threatens financial stability.

Understanding nature-related financial risks

Nature-related financial risks are defined as the risks of negative effects on economies, individual financial institutions, and financial systems. These are categorised as physical risks, stemming from the degradation of nature and the loss of ecosystem services, or transition risks, resulting from a misalignment of economic actors with actions aimed at protecting, restoring, or reducing negative impacts on nature. Ecosystem services provide society with tangible goods such as food and timber, as well as essential regulation of natural processes like carbon sequestration and flood control. Biodiversity is critical for the resilience and productivity of these ecosystems. The report identifies five main drivers of nature degradation: changes in land and sea use, over-exploitation of natural resources, climate change, pollution, and invasive alien species.

Assessing nature-related financial risks

The NGFS offers a principle-based framework consisting of three phases to help central banks and supervisors identify and assess material nature-related financial risks. This approach recognises that analytical methodologies and risk management practices are still developing and that specific actions will depend on the context and mandate of each jurisdiction. The framework adopts an integrated approach where climate-related financial risks are considered a subset of broader nature-related risks due to their strong interconnection.

Phase 1: Identify sources of physical and transition risk

The first phase involves identifying potentially material sources of risk from a microprudential, macroprudential, and macroeconomic perspective. This includes sector-based prioritisation, identifying activities like agriculture, forestry, and mining that have high impacts and dependencies on nature. It also includes ecosystem-based prioritisation. Analysis must incorporate a forward-looking dimension through scenario analysis to explore potential ecosystem collapses or policy shifts, such as the GBF target to protect 30% of land and water by 2030. Because nature is spatially explicit, efforts to identify risks should consider the specific geographical location of impacts and dependencies. However, local impacts can have systemic global implications through compounding effects, where the collapse of one ecosystem triggers the degradation of others.

Phase 2: Assess economic risks

As a second step, central banks and supervisors should assess the potential economic effects resulting from these exposures. Physical and transition risks affect businesses and households via direct (first-order) and indirect (value chain) transmission channels. At a micro level, this can result in damage to assets, stranded assets due to new regulations, and reduced labour productivity. At a macro level, risks manifest as inflationary pressures from rising commodity prices, productivity losses, and changes in trade and capital flows. The concept of substitutability is vital here; while some technological or geographical substitutes may mitigate some losses, many critical ecosystem services, such as climate regulation, cannot be easily replaced, leading to significantly higher economic costs as degradation reaches tipping points.

Phase 3: Assess risk to, from and within the financial system

The third phase considers how economic risks transmit to financial institutions and the broader system. Risks transmit through traditional prudential categories: credit risk arises from impaired collateral values and borrower defaults; market risk involves asset repricing; and operational risks include litigation against institutions financing activities that contribute to deforestation. The framework highlights endogenous risk, where the financial sector’s funding of harmful activities amplifies the physical risks to which it is exposed. Contagion may occur if exposures are concentrated in high-risk sectors or if highly exposed institutions are strongly interconnected, potentially creating negative feedback loops between the financial system and the real economy.

Pathways to action

The framework provides a common starting point for action across the NGFS membership. Central banks and supervisors are encouraged to identify, assess, and act on material risks while taking their specific mandates and jurisdictional contexts into account. The framework and its guiding questions can be used to facilitate a dialogue with the financial sector regarding risk identification, management, and disclosure. It also aims for interoperability with efforts from other global stakeholders, including the Basel Committee on Banking Supervision and the Financial Stability Board.

Forests illustrative case: The Amazon rainforest

The Amazon spans nine jurisdictions and hosts 40% of the world’s remaining rainforest. Degradation, primarily driven by agriculture and mining, threatens the ‘Amazon dieback’ tipping point, where the forest transforms into a dry savannah. This would non-linearly increase physical risks globally by disrupting the carbon cycle and precipitation patterns. Economic risks include significant productivity losses in the beef and soy sectors, with potential reductions in total output estimated at billions of euros. Financial risks are evidenced by research showing that 46% of Brazilian banks’ corporate loan portfolios are concentrated in sectors dependent on Amazon ecosystem services, with losses potentially leading to a 9 percentage point increase in corporate non-performing loans.

Freshwater illustrative case: The Colorado River Basin

The Colorado River Basin provides drinking water to 40 million people and supports approximately $8 billion in annual agricultural income. Climate-change-induced droughts are predicted to cause river flow to decline by up to 31% by 2050. This leads to reduced hydroelectric power generation and water scarcity for irrigated agriculture. Economic impacts could be severe, with estimates suggesting that 64% of the region’s annual gross state product could be lost if the river were no longer available. Financial risks manifest through increased default probabilities for water-dependent businesses, market volatility, and legal risks linked to water rights disputes. Financial institutions’ funding of water-intensive agriculture in these vulnerable areas amplifies these risks.