Programme: Central banking and financial supervision in the biosphere

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.

How soil degradation amplifies the financial vulnerability of listed companies in the agricultural value chain

27 January: If nature is not protected, at least USD 10 trillion of GDP will be lost by 2050 due to the decline of ecosystem services.  By identifying and assessing nature-related financial risks, nature can be integrated into financial decision making, recognising nature as the heart of the economy and remaking the relationship between people and the planet.

CISL and financial institutions have been conducting assessments of nature-risks. Using the Handbook for Nature-related Financial Risks (CISL, 2021), members from the Banking Environment Initiative and Investment Leaders Group are assessing the risks posed to specific sectors and geographies by degraded land, water curtailment and the EU Farm to Fork Strategy. To complement this analysis, the institutions are also mapping nature-risks in different share indices.

In this use case, Robeco quantified the financial risk of land degradation to the agricultural value chain, quantifying valuation impact.

Following an extreme weather event those along the value chain connected to degrading land saw a materially negative impact on valuation:

  • Farmers operating predominantly on degrading land saw their market value decline by 13 per cent
  • Small packaged food companies that source from areas of degrading land saw a negative impact on valuation as high as 45 per cent.
  • The smaller and less diversified a company, and the more connected to degrading land, the worse the valuation impact.

The analysis showcased the financial materiality of land degradation, underscoring the need for investors to incorporate factors like soil health into investment decisions. It also highlighted the need to actively engage with companies in the agribusiness sector to guide them to tackle nature-related risks in their business strategies.

Key points of upcoming use cases

With use cases ongoing and more due to be published, CISL published a preview of use cases in October 2021 containing the following key points:

  1. data exists today to assess some nature-related financial risks
  2. tools are available to map financial portfolio exposure to nature-related risks
  3. some responses to nature loss (transition risks) can be modelled today with limited specialist guidance
  4. first assessments of nature risk promote engagement within financial institutions and between financiers and companies
  5. the current lack of supply chain transparency is a key barrier to assessing the scale of risks.

Central banking and supervision in the biosphere

 

This event brings together a high-profile panel of international central banks and supervisors to discuss the implications of biodiversity loss for their operations and next steps. The findings of the report of the Joint NGFS-INSPIRE Study Group on Biodiversity and Financial Stability will be presented, followed by a panel discussion.

The report investigates and strengthens the case for action to enable central banks and supervisors to not only understand the issues the planet is facing due to the unparalleled loss of biodiversity but also to define the actions that must be taken within existing mandates in the collective effort to address this vital challenge. The report sets out how financial risks stemming from biodiversity loss can have implications for financial stability and therefore the core objectives and policy frameworks of central banks and supervisors. The decline of ecosystem services as a result of biodiversity loss poses physical risks for economic and financial actors that depend upon those services.

Meet our speakers and chair

Ma Jun is an Economist of the People’s Bank of China and currently the Chairman of the Green Finance Committee, China Society for Finance and Banking, President of Institute of Finance and Sustainability, Co-Chairman of the G20 Sustainable Finance Study Group, and the former member of the Monetary Policy Committee of the People’s Bank of China.

Otávio Damaso is Deputy Governor for Regulation of the Banco Central do Brasil. He previously served as Chief of Staff to the Governor of the BCB and as Deputy Secretary for Economic Policy at the Ministry of Finance.

Frank Elderson is the former chair of the Network of Central Banks and Supervisors for Greening the Financial System. He co-chairs the Task Force on Climate-related Financial Risks of the Basel Committee on Banking Supervision. Frank Elderson is also a member of the Executive Board of the European Central Bank. He oversees the ECB’s Legal Services and is Vice-Chair of the ECB’s Supervisory Board.

Sylvie Goulard was appointed second deputy governor of the Banque de France by the Council of Ministers on 17 January 2018 and has carried out most of her career in European institutions.

Chaired by Nick Robins, Professor in Practice, joined the Grantham Research Institute in February 2018 as Professor in Practice for Sustainable Finance. Nick leads the sustainable finance research theme. The focus of his work is on how to mobilise finance for climate action in ways that support a just transition.

Biodiversity and Financial Stability: building the case for action

8 October: Today, the joint Study Group on ‘Biodiversity and Financial Stability’ – launched in April 2021 by the NGFS and INSPIRE – published an Interim Report entitled “Biodiversity and Financial Stability: building the case for action”.

The Study Group is co-led by Dr Ma Jun (Chair of NGFS Workstream on Research and Special Advisor to the Governor of the People’s Bank of China) and Professor Nick Robins (Grantham Research Institute on Climate Change and the Environments) and comprises around 30 NGFS members and observers, and around 30 INSPIRE researchers, from academia, civil society groups and think-tanks. The document is published as part of the “NGFS Occasional Papers” series and, therefore, the views and opinions expressed do not necessarily represent those of the NGFS.

The report finds that there is growing evidence that biodiversity loss could have significant economic and financial implications because the decline of ecosystem services poses physical risks for the economic actors that depend upon them. These actors also face transition risks from policies designed to halt biodiversity loss, such as the post-2020 Global Biodiversity Framework, expected to be agreed at COP 15 conference in Kunming, China, next spring.

Frank Elderson, Chair of the NGFS and member of the ECB’s Executive Board: “Global policymakers are now becoming increasingly aware of the consequences of biodiversity loss. It is highly encouraging that NGFS and INSPIRE deliver their interim report on the risks of

biodiversity loss for the economy and the financial system and the implications for central banks and supervisors ahead of Biodiversity COP-15”.

This potential financial instability means that central banks and financial supervisors could start to better assess the risks associated with the loss of biodiversity. The authors recommend four steps that central banks and financial supervisors can tackle the problem:

  • First, they can begin building the skills, capacities, tools and cooperation to address biodiversity-related economic and financial risks;
  • Second, they can assess the dependencies and impacts of their financial institutions – through the economic activities they support – on ecosystem services and biodiversity. They can become more familiar with existing biodiversity-economy models and develop ad hoc methodological approaches that better capture the risk of impacts cascading through economic and financial systems;
  • Third, they could signal to the financial institutions that they supervise, other economic actors and policymakers the importance of understanding the risks arising from their dependencies and impacts on biodiversity;
  • Last, the authors say central banks and financial supervisors could, within the remit of their mandates support governments’ efforts to reverse biodiversity loss, in particular regarding the implementation of the post-2020 Global Biodiversity Framework by addressing financial risks and preparing the financial infrastructure required for nature-positive financing.

“This report shows the severity of the macroeconomic consequences of biodiversity loss and profiles the increasing efforts by central banks and supervisors to understand the implications for both financial institutions and for the system as a whole”, says Professor Nick Robins. “As we head towards the COP15 on biodiversity and COP26 on climate, it’s clearer than ever that these two imperatives need to be addressed in an integrated way, thereby helping to reduce the rising physical and transition risks from environmental depletion that are now facing the financial system.”

“A growing number of central banks and financial supervisors recognise the risks that climate change poses to financial stability. Biodiversity loss poses risks of similar, and perhaps greater magnitude to many countries, while it is also clear that climate and biodiversity are interlinked and often self-reinforcing issues”, says Dr Ma Jun. “Central banks and supervisors need to work on actions to guide financial institutions to protect biodiversity, including via requirements for them to assess the impact of investment activities on biodiversity and to disclose impact information.  However, central banks and regulators face considerable challenges – in terms of data, methodologies, tools and capacity – in understanding and responding to the risks posed by biodiversity. There is significant potential for bodies such as the NGFS to help central banks and financial supervisors cooperate in addressing these challenges.”

This Interim Report sets the stage for a final report from the Study Group, due to be published in early 2022. That report will explore in further detail linkages between biodiversity loss, the macroeconomy and the financial system, drawing on existing research and leading practice. The final report will more comprehensively consider options for central banks and financial supervisors to address the micro and macroprudential risks that biodiversity loss poses as well as set out a research agenda.

From Covid-19 to climate change and nature loss: how can a precautionary financial policy framework coordinate monetary, prudential and fiscal policies to address long term challenges?

In the face of climate-related financial risks, the Bank of International Settlements in its ‘Green Swan’ book demonstrated the importance of coordination between green fiscal policy, prudential regulation, and monetary policy. Such coordination must be underpinned by a shift in intellectual framework to facilitate financial policymaking under unprecedented global threat situations.

Aligned with this assessment, we propose to develop the Precautionary Financial Policy (PFP) framework, to address the dual issues of policy coordination and the need for an underlying paradigm shift. The PFP framework provides the theoretical justification for more ambitious financial policy interventions, in the face of the radical uncertainty characterizing long-term and potentially irreversible risks such as those posed by climate change and massive biodiversity loss.

The project will develop the PFP framework as a new paradigm that could support greater coordination between monetary, prudential, industrial, and fiscal policies (henceforth financial-fiscal) in the face of emerging climate- and nature-related financial risks. In particular, we will examine:

  • How this approach may provide a more coherent alternative than the ‘market neutrality’ principle in facilitating such coordination, in light of the recent European Central Bank’s declarations questioning this principle, and
  • How the PFP could help to deal with the problem of differing time horizons across policy spheres, institutions, and mandates that also mitigates against policy coordination.

The research will involve analysis of historical examples since the 1930s up to and including the most recent policy responses of financial-fiscal policy coordination and expanded institutional purpose to address Covid-19. We will develop a typology of financial-fiscal policy coordination and use this to formulate concrete policy recommendations in terms of institutional setup and governance.

Biodiversity and financial stability: exploring the case for action

18 June: NGFS and INSPIRE have established a joint Study Group on Biodiversity and Financial Stability, with the aim to understand the potential implications of biodiversity loss for financial stability.

Biodiversity is declining faster than at any time in human history. Policy efforts have been unable to slow the global loss of biodiversity, while the pressures driving this decline continue to intensify. In addition to increasing awareness of the impacts of economic activities on biodiversity, some central banks and financial supervisors are starting to recognise the potential of biodiversity loss as a threat to their core mandates for financial and monetary stability. Biodiversity loss could pose risks to the financial system through complex feedback loops, externalities and tipping points, including transition risks (e.g. incompatibility between financial institutions’ exposures and government measures) and physical risks (e.g. declining performance of assets or economic activities that depend upon biodiversity).

The global economy and financial system are embedded in the biosphere. Companies both depend on ecosystem services such as clean air and freshwater, and impact on the natural systems that provide those services. A range of market and institutional drivers explains the continued failure to value biodiversity but efforts to quantify the economic dependence on nature – as one aspect of addressing this failure – are growing. The financial system can both contribute to the depletion of biodiversity and promote its conservation and sustainable use.

The study group will explore whether and how central banks and supervisors can, within the remit of their mandates, play a role in addressing the challenge of biodiversity loss itself and the knowledge gaps around it, from assessment and monitoring of the relationship between biodiversity loss and financial stability to considering if central bank portfolios should include conservation goals. Applying a ‘double materiality’ approach to
biodiversity loss could be particularly insightful. Nature related hazards can affect companies and financial institutions, but companies and financial institutions can also affect biodiversity and the climate. This suggests
that a comprehensive approach to risk management should account for how financial institutions are exposed to biodiversity-related financial risks, but also how they contribute to such risks.

Finance, climate-change and radical uncertainty: Towards a precautionary approach to financial policy

Climate-related financial risks (CRFR) are now recognised by central banks and supervisors as material to their financial stability mandates. But while CRFR are considered to have some unique characteristics, the emerging policy framework for dealing with them has largely focused on market-based solutions that seek to reduce perceived information gaps that prevent the accurate pricing of CRFR. These include disclosure, transparency, scenario analysis and stress testing. We argue this approach will be limited in impact because CRFR are characterised by radical uncertainty and hence ‘efficient’ price discovery is not possible. In addition, this approach tends to bias financial policy towards concern around avoiding short-term market disruption at the expense of longer-term, potentially catastrophic and irreversible climate risks. Instead, an alternative ‘precautionary’ financial policy approach is proposed that offers an intellectual framework for legitimizing more ambitious financial policy interventions in the present to better deal with these long-term risks. This framework draws on two existing concepts — the ‘precautionary principle’ and modern macroprudential policy — and justifies the full integration of CRFR into financial policy, including prudential, macroprudential and monetary policy frameworks.