Regulators in some G20 countries are overlooking the financial risks posed by biodiversity loss and deforestation, according to a recent report (pdf) by the Financial Stability Board (FSB). While some regulators have assessed nature-related risks, many are still focused primarily on climate risks due to insufficient data on financial exposures to nature risks.

What’s at stake? The FSB warns that biodiversity and nature-related loss could lead to credit losses, defaults, and abrupt price corrections, posing significant financial risks to banks and other institutions. The World Bank also estimates that a partial collapse of the ecosystem could wipe off up to 2.3% of global GDP by 2030.

Assessing the risk: Financial authorities within FSB member jurisdictions are at varying stages of evaluating the relevance of biodiversity loss and other nature-related risks as financial risks, the report highlights. Some authorities have conducted analytical work and concluded that these risks are material, while others are still in the monitoring phase. A number of these authorities have decided not to prioritize the topic due to data gaps and the need to shift focus instead on climate risks, where more progress has been made.

The breakdown: Nature-related financial risks are categorized into physical risks and transition risks. Physical risks arise from the degradation of nature, affecting economic activities that rely on ecosystem services. Transition risks stem from actions aimed at protecting or reducing negative impacts on nature. These risks can have significant effects on the real economy and the financial system through typical transmission channels such as credit risks, market risks, and operational risks. There is also a growing focus on ins. underwriting risk due to rising damages from nature deterioration.

This has been a hot topic for a while: The Taskforce on Nature-related Financial Disclosures(TNFD) — which was launched in 2021 and endorsed by the G7 bloc to create a framework for organizations to report on nature-related risks — saw a 30% increase in adopters of their corporate reporting recommendations at London Climate Action Week in June. With 96 new organizations joining, the total number of adopters has reached 416, representing over USD 6 trn in market capitalization. Some 114 financial institutions were now registered as adopters under the TNDF with some USD 15.9 tn in assets under management, according to the TNFD.

MENA is in a precarious situation: The World Government Summit highlighted the urgent need for Middle Eastern governments to adopt the TNFD’s framework, according to a report (pdf) by American management consulting firm Oliver Wyman. The region faces severe consequences from environmental degradation, including impacts on agriculture, fisheries, tourism, and desalination. The framework builds on existing climate-related disclosure standards, emphasizing the importance of transparency and accountability in financial decisions.

Costs are running high: The MENA region has seen around USD 2 bn in direct damages annually since 2000 as a result of climate-related disasters with temperatures rising twice as fast as the rest of the world, according to the IMF. This also led to further fiscal strain, decreasing government revenue and increasing public debt by an estimated 3% of GDP.

Morocco’s climate-related risks are sparking concern: Morocco’s growing vulnerability from droughts and floods are exacerbating risks to its economy and banking sector. Drought scenarios could lead to GDP reductions ranging from 1.8 to 3.5 percentage points, while pluvial flooding could cause losses ranging from c. USD 9 bn to USD 10.8 bn by 2050 depending on its severity.

Iraq is struggling as well: Iraq has lost approximately 60% of its irrigated agricultural lands due to severe water shortages and climate change. Last year, Iraq’s reservoir capacities were at their lowest levels in decades — half of levels recorded in 2018 — as neighboring Iran and Turkey continued to hike domestic flows from local dams on the Tigris, Euphrates, and other waterway channels. Such a crisis is expected to lead to an increase in a widening gap between water supply and demand to 5 bn to 11 bn cubic meters by 2035, according to the World Bank. This would lead to a reduction in crop yields and the country’s agrifood systems, putting food security and the economy at risk, the World Bank said.

There are still challenges to address: The FSB report identifies major data and modeling challenges faced by authorities currently embarking on analytical work. There is a lack of reliable and consistent data on financial exposures to natural risks, and understanding of the data needs is still at a formative stage. However, authorities' work to date indicates that financial institutions face large exposures to physical risks via their investments and financing activities. However, more work is needed to translate these exposures into measures of risk.

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