Euro area banks vulnerable to nature degradation risks
A new European Central Bank study reveals that 75 percent of euro area corporate loan exposures are highly dependent on ecosystem services. Continued nature degradation could significantly increase banks' credit losses, with particular vulnerabilities in certain regions and sectors.
Deep roots in nature's services
The study assesses the dependencies of euro area non-financial corporations (NFCs) and banks on various ecosystem services.
It finds that approximately 72 percent of NFCs, representing around 3 million individual entities, are highly dependent on at least one ecosystem service.
This dependency extends to the financial sector, with almost 75 percent of corporate bank loans in the euro area granted to NFCs with high reliance on such services.
The paper highlights that physical risks, such as declining pollinating insects or reduced flood protection from deforestation, directly threaten these corporations.
Previous research by De Nederlandsche Bank found 36 percent of Dutch financial institutions' portfolios exposed, while the Banque de France reported 42 percent of French securities dependent.
The Bank of England found 52 percent of UK GDP and 72 percent of UK lending reliant on ecosystem services.
Triple losses in a disorderly future
The sensitivity analysis reveals that euro area banks are vulnerable to future biodiversity losses.
If global emissions continue their current trajectory, banks' credit portfolio losses could be almost three times higher on average compared to a Paris-aligned future scenario.
The study projects the most significant losses, up to five times higher, in countries such as Germany, Lithuania, Ireland, and Belgium.
The Network for Greening the Financial System (NGFS) acknowledges nature-related financial risk as a critical concern for central banks and supervisors, emphasizing the need to assess financial systems' exposure to nature degradation.
The NGFS has also published a conceptual framework to guide policy and action.
Overdue clarity, urgent action
This ECB paper provides crucial, data-driven insights into a systemic risk that has long been underestimated by the financial sector.
While the findings underscore the urgency of integrating nature-related risks into financial stability frameworks, significant gaps in disclosure and quantitative modeling persist.
Supervisors must now leverage these insights to push for robust risk management and transparent reporting across the banking sector.