Nature risk poses ‘major data and modelling challenges’ – FSB

Supervisors face “major data and modelling challenges” in addressing nature-related financial risks, which partly explains limited progress to date, the Financial Stability Board says.

The FSB published a “stocktake” of work on nature-related risk today (July 18), ahead of a meeting of central bankers at the Group of Twenty summit next week.

Regulatory and supervisory work in this area is generally “at an early stage”, the FSB says. “Supervisory guidance, where it exists, typically covers nature-related risks as part of an overall focus on environmental risks,” the report says. Nature-related guidance tends to be less detailed than guidance on climate change.

The report highlights how authorities are generally approaching nature-related risks in the same fashion as climate risks, focusing on both physical and transition risk. Studies so far have found financial firms have “large exposures” to physical nature-related risk via their investments and lending.

But, as the FSB report emphasises, data on nature-related risks is sparse and modelling frameworks are much less developed than for climate risk. Supervisory approaches typically focus on encouraging firms to make better disclosures of their risks, but such disclosures are generally at an earlier stage than for climate change metrics.

The Network for Greening the Financial System (NGFS) has recently stepped up its work on nature-related risks, publishing a “conceptual framework” to guide central banks in September 2023. As with climate change, the NGFS report notes the degradation of nature can impact financial firms directly, while policies designed to protect nature could also destabilise some firms with large exposures.

Ecosystems have an impact on the economy via “ecosystem services”, the ways in which nature provides society with “tangible goods”, as the NGFS report puts it. Examples are insect pollination, carbon sequestration, trees providing timber, and nutrient and water cycles.

The FSB notes there is no globally agreed system for defining nature-related financial risks, though groups including the NGFS and Taskforce on Nature-related Financial Disclosures are working in this direction.

The FSB stocktake includes several case studies of central banks that are scrutinising nature-related risks in their supervision. Nature-related risks are included in supervisory assessments by the European Central Bank, Banque de France, Netherlands Bank and Bank of Italy.

Other authorities say they are focusing resourcing on climate risks. The Australian Prudential Regulation Authority has “future plans” to assess nature-related risk, while Japan’s Financial Services Authority “has yet to conclude that nature-related risks are sufficiently relevant to financial stability”. The Bank of England says it will consider issuing guidance “if it determines that nature-related risks are material in the appropriate time horizon”.

Environmental organisations are pushing for more action from central banks. The World Wide Fund for Nature (WWF) published a report on July 17 arguing central banks already have the tools to understand and act on risks from deforestation and the “conversion” of non-forest ecosystems.

“Tools to understand the exposure of deforestation and conversion are available,” said Maud Abdelli, WWF’s greening financial regulation initiative lead. “The integration of deforestation and conversion in financial regulation and monetary policy can help modulate financial flows towards environmentally harmful activities, mitigate future financial risks and ensure a resilient financial system.”