A natural re-connection: the economic imperative and risks associated with Nature

“The wealth of a nation is its air, water, soil, forests, minerals, rivers, lakes, oceans, scenic beauty, wildlife habitats and biodiversity. That’s the whole economy. These biological systems are the sustaining wealth of the world” – Gaylord Nelson.

Over the past two years across the world, many of us have all felt pain and hardship associated with Covid-19 and endured several restrictions to combat the pandemic. During this bleak period, however, many of us managed to find some special solace. We managed to reconnect with Nature. Across Northern and Southern hemispheres, we begun to notice the small things that each day brought. The morning cry of birdsong, the midday buzz of pollinators, and the evening howl of ample critters. In the tropics, some of us waltzed through rainforests, inspected insects with awe and relished the cool air the forests afforded us.

For many of us, our time spent fully immersed in the wonders of the natural world rejuvenated us, as we tried coped with the unprecedented changes to the way we lived.  As we enjoyed Nature’s beauty, we also began to appreciate and understand its economic significance. It became clear as night and day – from truly observing night and day – that our economies are embedded in Nature and that they fundamentally rely on the services provided by the natural world.

Within the global financial system, there has also been increasing appreciation and understanding of this fundamental truth. More so, that biodiversity is critical to sustaining our economic and financial activities. Biodiversity – that is the diversity of Nature – enables Nature to be productive, resilient and adaptable. All economic activities depend to some degree on Nature, and we now know that at least half of global economic activity is moderately or highly on services provided by Nature. However, biodiversity is declining at rates faster than ever before in human history – and with this comes a set of challenges for our economy, societies, and us as individuals.

Over the past half a decade, central banks and financial supervisors have deepened their understanding and response to climate change. They have understood the links between a warming planet and financial stability, and taken a range of actions such as embedding climate-related risks considerations into micro- and macro-prudential policies, developing climate scenarios for financial stability assessment, and collaborating internationally on best practice for example through the Network for Greening the Financial System (NGFS).

However, it is being increasingly recognised among central banks and financial supervisors that climate change is not the only significant, non-linear, and potentially existential environmental risk facing companies and financial firms, and greenhouse gas emissions are not the only environmental impact facilitated by financial activities. Within these communities, it is being accepted that nature-related financial risks, including those associated with biodiversity loss, have significant macroeconomic implications, and that failure to account for, mitigate, and adapt to these implications is a source of risks for individual financial institutions as well as for financial stability.

This was the from key finding from the NGFS-INSPIRE report, ‘Central banking and supervision in the biosphere: An agenda for action on biodiversity loss, financial risk and system stability’, published last month. The report – building on Vision and Interim reports – was designed to help all central banks and financial supervisors understand the issues in the context of existing science, theory, policy and practice, and to recommend steps that could begin to address nature risks in their respective financial systems.

It highlighted that central banks and financial supervisors should develop strategies to address nature risks because these risks share some key characteristics with climate risks. That is, nature risks stem from the same risk factors as climate risks: physical and transition.  Nature risks are also far-reaching in breadth and scope (natural systems and processes are subject to complex, non-linear dynamics and potentially irreversible changes when tipping points are crossed), foreseeable yet uncertain (the expected trends for nature loss and associated policy outlook means that some combination of physical and transition risk will materialise over the longer term), and delayed action brings greater risk (evidence suggests we are fast approaching multiple ecosystem tipping points based on current trends).

However, the nature of Nature means that nature risks have distinct challenges that make them even harder to identify and assess relative to climate risk. Specifically, these risks arise from a wide variety of sources – such as deforestation, species loss, water scarcity and pollution – and therefore cannot be captured in a single metric, like carbon emissions for climate. Nature risks are also relatively more location-specific than climate risk. And while nature loss occurs at the local level, the interlinkages across ecosystem services means that disruptions to one can spillover to multiple others, with the potential of ‘domino effects’ and spillovers across economies. These elements mean that nature risks can affect the financial system through multiple sources and transmission channels, which makes them conceptually challenging.

While comparing and contrasting climate risks and nature risks is possible, the issues of climate change and biodiversity loss are inextricably interlinked. Climate change is one of the five key drivers of biodiversity loss, with adverse impacts on ecosystem services that can then drive further changes in climate. In addition to being a direct driver, climate change also worsens other drivers of biodiversity loss. For example, changes in temperature and weather enables the quick spread of invasive species. On the other hand, biodiversity loss exacerbates climate change through degrading carbon storage, releasing carbon emissions and altering natural infrastructures crucial for climate resilience. There is a broad scientific consensus that Nature will play a critical role in the net zero transition, as actions to conserve, restore and sustainably use natural assets (such as land and oceans) simultaneously provide significant climate benefits.

Climate risks and some sources of nature risks are positively correlated and reinforcing. However, nature loss introduces new sources of financial risk that are unrelated to climate risks , where such loss can potentially exacerbate climate-related financial risks. For example, the potential extinction of whales from overfishing, which given their importance in terms of carbon capture, could exacerbate climate risks. IMF work suggests that reversing whale depletion could result in carbon capture equivalent of over 3% of annual global emissions. Such nature impacts and potential financial risks will not be necessarily captured by responses solely to climate risks.

The beauty of biodiversity’s complexity means that its loss can be a beast in terms of a problem to tackle. Challenges are numerous including insufficient tools and metrics to allow for precise measurement, difficulties in conducting scenario analysis to size for potential magnitudes, and the lack of informative data to allow for greater economic and financial understanding in terms of location of nature and economic activities. For example, most of the world’s biodiversity is located in emerging and developing countries and its losses would likely not be confined to within borders but rather transmit across supply chains. 

However, these challenges are not insurmountable, and should not be an excuse for inaction. There are already innovations to help economists and financiers make sense of the implications of biodiversity loss. In addition, central banks and supervisors around the world have already started to use some tools and methods to understand nature risks. The establishment of the new NGFS taskforce to mainstream the consideration of nature-related financial risks across its activities should only further deepen understanding, effort and actions in this area. While current collective understanding, data and evidence of nature risks remains firmly in their infancy, the experience and lessons from building out our understanding of climate risks should give us good cause for optimism.

As the Covid pandemic has shown a bright light on, we rely on Nature to thrive. But Nature also relies on us – a circle has neither a beginning nor an end. As the world around us continues to slowly emerge from the pandemic, we should not lose what we have gained: our reconnection to Nature. As we heal from pandemic trauma, we must also pursue efforts with vigour to allow the natural world to also heal. We would do well to remember the role that Nature has played in helping us get to where we are, and the role its needs to play to where we want to get to.

By Elena Almeida and Thomas Viegas

Any views are that of the authors and not of any institutions or organisations.

Photo credit: Simon Wilkes, Unsplash.