NGFS-GRASFI-INSPIRE Exchange – Central banking and supervision in the biosphere

Co-chairs of the Joint NGFS-INSPIRE Study Group on Biodiversity and Financial Stability, Nick Robins (LSE & INSPIRE) and Dr Ma Jun (PBC & NGFS) will present the Study Group’s final report “Central Banking and Supervision in the Biosphere” and share their perspectives on nature’s role in supporting financial stability.

 


The NGFS-GRASFI-INSPIRE Exchange is designed to strengthen the connection, collaboration and research exchange between the central bankers, financial supervisors and the academic community to share and explore new and innovative research that advances the agenda on greening the financial system. New editions occur monthly and are co-organised by the NGFS Secretariat, INSPIRE and GRASFI (the NGFS’ two designated global research stakeholders). This session is the 1st in a 7-part series exploring dimensions of Environmental Risks, such as biodiversity loss and environmental degradation, and reflects the NGFS’s ambition to broaden its scope beyond climate-related risks. This 16th edition of the Exchange is hosted by the NGFS..

Biodiversity and Economic Growth: Something Must Give

28 March: The level of world economic activity driven by explosive growth in population and living standards since the late 18th century has reached utterly unprecedented levels under a longer-term view. Equally astonishing has been the pace of environmental degradation because of this expansion. According to recent NGFS scenarios, successful mitigation of climate change–the most salient dimension of such degradation– need not materially affect world GDP in the long run, and thus chiefly constitutes a problem of risks, whose successful management would allow to achieve similar growth outcomes.

This paper reviews the recent evidence on biodiversity loss and ecosystem degradation, an equally important but much less salient dimension of the environmental crisis. Simple calculations suggest halting its alarming recent trends will involve problems of both first as well as second moments: the transition will have to deal with risks, but even a successful management of these will probably require adjusting expectations about the possibilities of future economic and population growth. We believe this contrast should receive special attention as the focus of environmental-economic modelling in general, and the seminal work by the NGFS in particular, expanding its focus to include biodiversity in macro-financial analysis. We also present new evidence consistent with the intuition that population growth dominates the negative impact of growth on biodiversity, especially since the second half of the 20th century. This supports the notion that territories rich in biodiversity, but poor and in the early stages of the demographic transition will be critical for the preservation of natural capital.

Ecological Accounting: How to organize information for biodiversity conservation decision and action at the national, business and ecosystem levels?

24 March: In order to contribute to the multiple efforts for the transformation of our economy into a system that effectively maintains and restores biodiversity, we introduce a proposal aimed at going further in the integration of ecosystem-interdependencies
information at the heart of organizational processes and decision-making procedures at different levels. These methods also aim to take into consideration the great variety of decision-making and action contexts that characterize the realm of biodiversity conservation. We argue that such an endeavor requires to turn to the field of “ecological accounting”, both on a conceptual level and on a practical level, to put forward concrete methods and tools for collective decision and action.

The
paper hence addresses the following question: what kind of ecological accounting concepts and methods can be sense-making and scientifically sound, to support the management of biodiversity-related risks and reorganize our economic system towards the achievement of biodiversity conservation/restoration goals ?

Central Banking and Supervision in the Biosphere

24th March: NGFS-INSPIRE Study Group on Biodiversity and Financial Stability have published their final report ‘Central Banking and Supervision in the Biosphere: An agenda for action on biodiversity loss, financial risk and system stability’.

It finds biodiversity loss poses a significant and under-appreciated threat to financial stability, and central banks and financial supervisors should act to confront nature-related risks. The report argues that economic activity and financial assets depend upon the ecosystem services provided by biodiversity and the environment. This means that there are physical risks to finance if these services are undermined. But the transition to a global economy that protects nature also creates potential risks related to policy, technology, market and reputation. In addition, the financial system has an impact on biodiversity through the economic activities that are enabled by its lending, investment and insurance.

The report provides the first global assessment of why and how central banks and supervisors can respond to rising risks from biodiversity loss. It identifies 45 examples of authorities already taking action in countries such as Brazil, China, France, Malaysia, the Netherlands and the UK. It concludes that these initial first steps now need to be developed into a comprehensive response. To achieve this, the report makes five recommendations:

  • Central banks and supervisors should recognise biodiversity loss as a potential source of economic and financial risk and commit to developing a response strategy. Financial authorities could include biodiversity loss within their green finance and environmental strategies, taking an integrated approach which highlights the links with climate change as well as the specific threats that it might pose to financial and price stability.
  • Central banks and financial supervisors should build the skills and the capacity to analyse and address these risks. This should cover central bank and supervisory staff as well as market participants and other stakeholders. Emerging and developing economies have particular needs for capacity-building, and there is a rich agenda for further research to strengthen the evidence-base.
  • Central banks and financial supervisors need to assess the degree to which financial systems are exposed to biodiversity loss. This could include conducting assessments of financial sector dependency and of impacts on biodiversity, as well as developing biodiversity-related scenario analysis and stress tests, and helping to create a dashboard of biodiversity metrics.
  • Central banks and supervisors need to explore options for supervisory actions to manage biodiversity-related risks and minimise negative impacts on ecosystems. This could include the development of supervisory expectations of financial institutions such as banks, insurers and investors in relation to governance, risk management and strategy, disclosure and financial conduct.
  • Central banks and financial supervisors can help to build the necessary financial architecture for mobilising investment that helps to conserve biodiversity. This could include contributing to the development of biodiversity taxonomies, exploring options for integrating biodiversity-related considerations into monetary policy, and incorporating biodiversity protection within central bank investment portfolios.

In addition, the report sets out a research agenda for central banks and academic researchers to continue to address some of the analytical and data gaps that the study group identified in the course of its work. Developing scenarios that describe the possible impacts of biodiversity loss, analogous to those developed for climate, is likely to be an area of particular focus.

In response to the work of this Study Group the NGFS has issued a statement announcing it will establish a task force to mainstream the consideration of nature-related financial risks across its activities.

Read the NGFS statement here.

Read the NGFS’s press release here.

Read INSPIRE’s press release here.

From financial risk to financial harm: Exploring the agri-finance nexus and drivers of biodiversity loss

24 March: There is growing awareness amongst both financial policy makers and financial institutions of the need to better understand the links between the financial system and biodiversity loss. Central banks and financial supervisors have so far focused more on the risks posed by biodiversity loss to the financial system (“financial materiality”) than the impacts of finance on biodiversity (“environmental materiality”).  In the wider biodiversity-finance sphere, the emphasis has been on the creation of new financial products or investment opportunities associated with the restoration of nature or offsetting damages – so called ‘nature-based solutions’. Less attention has been paid to the institutional relations that connect macro-financial and ecological systems and the growing importance of financial actors, incentives, and practices in shaping human demands upon the biosphere.

In this context, we study the agri-finance nexus and find that finance-oriented practices such as maximizing agricultural land productivity, realising capital gains, and achieving scale are systemically associated with land-use change and intensive agricultural practices that drive biodiversity loss and degradation. Importantly for policy makers, these findings indicate the financial sector to be indirectly contributing to the threat of breaching critical ecological tipping points, which would pose systemic macrofinancial risks. Central banks and supervisors should focus their attention on encouraging the avoidance of such practices by employing both monetary and (macro-)prudential policy toolkits. Given such activity falls outside the sphere of standard financial regulation, to do so will require greater coordination with other government departments, including environment agencies as well as international financial agencies.

A Dashboard for Biodiversity Risk Metrics

24 March: This policy brief calls on central banks and financial supervisors to build and use a dashboard of biodiversity metrics to assess biodiversity risks in terms of both dependencies and impacts. In order for these metrics to become fully operational, they should cover risks for firms and households, account for the risks of tipping points, and address micro and macro dimensions of biodiversity risks – including systemic societal risks. They should furthermore include geographical information to cover the location of economic activities (including the supply chain) and the local state of biodiversity loss. Moreover, these metrics should be able to reflect the vulnerability and resilience of companies and households vis-à-vis biodiversity risks.

Given the rapid development of biodiversity risk metrics and the rise of sustainable finance, central banks and financial supervisors can and should take a leading role in establishing an appropriate institutional framework to further develop these metrics and ensure that they are trustworthy and can be used effectively. Collaboration with various actors in an inclusive and open way is crucial for the success of this endeavour. This process will also support the various institutions in providing the data for the dashboard, contributing to the development of metrics, and building up their own implementation capabilities.

Nature loss threatens financial stability and central banks should act: new report

Biodiversity loss poses a significant and under-appreciated threat to financial stability, and central banks and financial supervisors should act to confront nature-related risks, according to a new report published today (24 March 2022) by

a group of central bankers, financial supervisors and academic researchers.

The report argues that biodiversity loss poses systemic risks in the same way as climate change. It calls for a concerted response by central banks and financial supervisors similar to that triggered by warnings on climate risk six years ago from Mark Carney when he was Governor of the Bank of England.

The report on ‘Central banking and supervision in the biosphere: An agenda for action on biodiversity loss, financial risk and system stability’ is co-authored by a special study group set up by the Central Banks and Supervisors’ Network for Greening the Financial System (NGFS) and INSPIRE, an independent research network. The study group consisted of more than 100 central bankers, supervisors and researchers.

The study group was co-chaired by Nick Robins, who is professor in practice for sustainable finance at the Grantham Research Institute on Climate Change and the Environment at the London School of Economics and Political Science, and also co-chair of INSPIRE. He said: “Biodiversity loss is potentially as economically and financially impactful as climate change, but has so far received much less attention. This report shows that these twin threats now need to be tackled in a joined-up way by central banks and supervisors to build a nature-positive financial system.”

The study group was also co-chaired by Ma Jun, who is Chair of the NGFS Workstream on Research and Special Advisor to the Governor of the People’s Bank of China. He said: “International efforts to halt biodiversity loss are intensifying, with agreement expected this year at COP15 in Kunming, China, on a new Global Biodiversity Framework. This report shows that addressing biodiversity-related financial risks clearly falls within the mandates of central banks and supervisors and sets out the role they can play to bring the Framework to life across the financial sector.”

Ravi Menon, Managing Director of the Monetary Authority of Singapore and Chair of the NGFS, said: “Biodiversity loss could have significant macroeconomic implications.  Failure to account for, mitigate, and adapt to these implications is a source of risks relevant for financial stability.”

The report argues that economic activity and financial assets depend upon the ecosystem services provided by biodiversity and the environment. This means that there are physical risks to finance if these services are undermined. But the transition to a global economy that protects nature also creates potential risks related to policy, technology, market and reputation. In addition, the financial system has an impact on biodiversity through the economic activities that are enabled by it lending, investment and insurance.

The report provides the first global assessment of why and how central banks and supervisors can respond to rising risks from biodiversity loss. It identifies 45 examples of authorities already taking action in countries such as Brazil, China, France, Malaysia, the Netherlands and the UK. It concludes that these initial first steps now need to be developed into a comprehensive response. To achieve this, the report makes five recommendations:

  • Central banks and supervisors should recognise biodiversity loss as a potential source of economic and financial risk and commit to developing a response strategy. Financial authorities could include biodiversity loss within their green finance and environmental strategies, taking an integrated approach which highlights the links with climate change as well as the specific threats that it might pose to financial and price stability.
  • Central banks and financial supervisors should build the skills and the capacity to analyse and address these risks. This should cover central bank and supervisory staff as well as market participants and other stakeholders. Emerging and developing economies have particular needs for capacity-building, and there is a rich agenda for further research to strengthen the evidence-base.
  • Central banks and financial supervisors need to assess the degree to which financial systems are exposed to biodiversity loss. This could include conducting assessments of financial sector dependency and of impacts on biodiversity, as well as developing biodiversity-related scenario analysis and stress tests, and helping to create a dashboard of biodiversity metrics.
  • Central banks and supervisors need to explore options for supervisory actions to manage biodiversity-related risks and minimise negative impacts on ecosystems. This could include the development of supervisory expectations of financial institutions such as banks, insurers and investors in relation to governance, risk management and strategy, disclosure and financial conduct.
  • Central banks and financial supervisors can help to build the necessary financial architecture for mobilising investment that helps to conserve biodiversity. This could include contributing to the development of biodiversity taxonomies, exploring options for integrating biodiversity-related considerations into monetary policy, and incorporating biodiversity protection within central bank investment portfolios.

In addition, the report sets out a research agenda for central banks and academic researchers to continue to address some of the analytical and data gaps that the study group identified in the course of its work. Developing scenarios that describe the possible impacts of biodiversity loss, analogous to those developed for climate, is likely to be an area of particular focus.

This report is the final publication from the NGFS-INSPIRE study group, which was set up in 2021.

Explore the Study Group’s findings and recommendations here

Quantifying Financial Impacts of Biodiversity? Conceptual and Theoretical Frameworks, Limits, and Implications

22 March: The issue of biodiversity has entered the sphere of finance very recently, precipitating the confrontation of two divergent universes. Such a marriage of the living world and its natural complexity with the area of numbers, money and ‘rational’ economic agent decision is indeed not intuitive. This short paper reviews the different conceptual and theoretical frameworks called upon to apprehend, capture, and integrate biodiversity, and more broadly nature, into the financial system via its various components, with a focus on financial supervisors and monetary authorities. We analyse in particular the challenge of quantifying how biodiversity loss can affect a financial product, portfolio or institution through the use of traditional concepts such as prices and financial risk and examine the main limitations and implications of such approaches.

An Exploration of Nature-Related Financial Risks in Malaysia

15 March: Bank Negara Malaysia and the World Bank published today a report entitled “An Exploration of Nature-related Financial Risks in Malaysia”.

This exploratory study, jointly undertaken by Bank Negara Malaysia and the World Bank, uses local and global data to examine the relationship between the Malaysian financial sector and nature. It also assesses potential exposures to nature-related risks through banks’ financing activities.

Bank Negara Malaysia Governor Tan Sri Nor Shamsiah said, “Ecosystem and planetary health matters to economic and financial stability. While the primary responsibility for addressing these priorities rests with the government, the financial industry and authorities have a critical interest in deepening our understanding and appreciation of the interactions between climate and nature-related risks – because how these risks evolve, both affect and are affected by, the actions of financial institutions.”

“By identifying and quantifying nature-related financial risks, authorities will be better positioned to prioritize initiatives within their scope of mandate in managing this concern,” said Ndiame Diop, World Bank Country Director for Brunei, Malaysia, Philippines and Thailand. “We are happy to have partnered with Bank Negara Malaysia to support their leadership on this issue. This report is the first of its kind published by a central bank in Asia. We hope that it will provide an example for other countries facing similar challenges,” added Ndiame.

The report provides a launch pad for further study on nature-related risks and highlights the importance of tackling nature loss and climate change in a coherent manner. It also recognises the opportunity to leverage on the progress made on climate initiatives to address broader nature-related risks. Bank Negara Malaysia will continue to engage with the financial sector and other key stakeholders to build capacity in this area.