Central banks are gaining new insights into financial risks associated with deforestation and other land use changes and are encouraging widespread uptake of a novel framework to assess these risks, an Environmental Finance webinar heard.
Carlijn Ginther, sustainable finance officer at De Nederlandsche Bank (DNB), told attendees that research by central bank members of the Network for Greening the Financial System (NGFS) showed “risks stemming from nature and nature-related risks, including those associated with biodiversity loss, to which deforestation contributes, could have significant macroeconomic implications”.
“If there’s failure to account for, mitigate or adapt to these implications, that could also result in sources of risk for individual financial institutions, as well as for financial stability,” Ginther told the webinar, which was sponsored by WWF.
It comes as WWF’s Greening Financial Regulation Initiative publishes guidance for central banks, financial regulators and supervisors to address deforestation and conversion of non-forest ecosystems.
Ginther explained how DNB had worked as part of the NGFS to pilot a nature-related conceptual risk analysis framework, which included a case study focused on forests as well as one on water, and which gives “a shared framework for central banks and supervisors that is intended to be actionable”.
The analysis explored the “transmission channels” of various risks related to forests, including credit risk from “decreasing creditworthiness of sectors dependant on the forest which suffer from income losses, with reduced agriculture productivity affecting the incomes of debtors along the supply chain and then financial institutions may find these clients unable to continue to service those obligations”.
Asked why the Dutch central bank was assessing risks related to deforestation and other land use change, Ginther said: “For instance, [deforestation and land use change in and around] the Amazon rainforest, their effects go way beyond country borders – their effects on rain patterns in North America, for instance.
“We cannot not take them into account.”
DNB became the first central bank to carry out a LEAP (locate, evaluate, assess and prepare) assessment on nature earlier this year and in 2020 published a report on the nature-related impacts and dependencies of the Dutch financial system – finding that a total of €510 billion ($551.9 billion) was highly or very highly dependent on one or more ecosystem services.
While deforestation is not a recent development, Pablo Pacheco, global forest lead scientist at WWF Global Science, said central banks were beginning to assess the related financial risks because they better understand the link between climate and nature-related risks.
“Central banks have done a good job on factoring the risks from climate into their modelling and perspectives about the future scenarios of the economy. But now they need to add this one more [deforestation and land conversion].
“It is important to understand the interactions between climate change and biodiversity loss and how that can create cascading effects that may have impacts on the on the economy but also on the financial system and the future financial stability of economies,” Pacheco said.
David Valente, head of the advisory division on international financial regulation at the Banco Central do Brasil (BCB), told the webinar that its dual approach to assessing and managing such risks encompasses social and environmental disclosure rules for financial institutions and its role as regulator of a ‘rural credit’ programme.
It runs a ‘bureau’ to oversee adherence to the regime, which is designed to ensure bank lending incentivises sustainable use of land and discourages deforestation and other land conversion.
Meanwhile, the BCB is preparing to publish updated disclosure rules in the coming months that will require more quantitative environmental and social information, “in line with the IFRS S1 and S2 standards” and expected publication by the Basel Committee on Banking Supervision of Pillar 3 requirements on disclosure of climate indicators.
Watch a recording of the webinar here.
This article was updated on 17 July to add a link to WWF's report on deforestation and land conversion.