Five years ago, banks were faced with the challenge of measuring climate risks and integrating them into their risk management. Now, biodiversity loss is gaining attention and is joining climate risks on the political and regulatory agenda. Experience from the climate sector provides a valuable basis for all risk management processes. However, biodiversity risks are significantly more complex and extensive, which leads to challenges right from the definition and identification stage. Many institutions have started to assess their portfolios via established data providers such as Exploring Natural Capital Opportunities, Risks and Exposure (ENCORE). However, regulatory requirements go far beyond qualitative heat maps. Although there are still significant challenges in scenario development and quantification, there are already helpful approaches on the market that can be used to calculate parts of the biodiversity risk – or more accurately: the ‘natural risk’.
Experience from the climate context provides a valuable basis for dealing with natural risks. However, the latter brings additional challenges that make the situation more difficult – particularly due to the larger scale and greater complexity.
1. High number of drivers and lack of measurability
In addition to climate change, land and sea use changes, pollution, resource use and invasive species are considered to be the main causes of biodiversity loss. There is therefore no clearly measurable metric for transitory biodiversity risks, such as CO2 emissions for climate risks. On the physical side, there are numerous ecosystem services that could be lost to humans and the economy. These are often more difficult to grasp than physical climate risks and therefore more difficult to measure. In addition, both physical and transitory risks depend on sector and location, which requires an enormous amount of necessary – and usually unavailable – data to properly assess the risks.
2. Complex, multidimensional channels of action
Compared to climate risks, nature-related risk drivers have particularly high interactions with each other. Poor water quality, for example, can affect the health of humans and ecosystems and create supply bottlenecks, while also causing transitory risks. This describes the principle of double materiality and is particularly pronounced in the context of nature. Measures to protect biodiversity usually have the greatest impact where there is also the greatest physical risk, which creates a blurring between physical and transitory risks.
3. Uncertainties about future developments
Political measures to curb the loss of biodiversity are currently not formulated in sufficiently concrete terms. As a result, there is a lack of clear points of reference, particularly for transitory scenario analyses. For physical risks arising from the loss of ecosystem services – similar to chronic climate risks – there is a lack of comparable events from the past, which creates great uncertainty across all risk drivers.
According to the World Economic Forum’s Global Risk Report 2024 [2], the risk of biodiversity loss and ecosystem collapse will increase the most of all risks in the coming years. Although the risk currently ranks 20th among all risks, the report predicts that it will become one of the three most dangerous risks for the global economy in the next ten years. For physical risks, however, there are currently only a few scientific simulations that can be used for scenario analyses or quantification approaches.
Even if physical biodiversity risks are not expected to have a major impact on most institutions in the short term, the opposite is true for all institutions in the long term, regardless of their business model. This is because the loss of species and ecosystems is irreversible and disrupts the balance of nature comprehensively, with largely unknown consequences. Such losses can trigger chain reactions that endanger other species and ecosystems. In view of the rapid rate of biodiversity loss, considerable natural risks are to be expected in the long term. Macroeconomic and systemic effects such as food shortages and health risks will be felt globally and affect large sections of the world’s population.
There are already more analyses on the market for analyzing transitory risks and initial quantification approaches. In order to limit the scope and complexity, it seems sensible to focus on the most important risk drivers and impact channels. Public assessment tools such as ENCORE [3] and a look at the targets set as part of COP15 [4] show that direct impacts arise primarily in the primary sectors.
Resource use is a major topic in the area of natural risks. This can be further narrowed down using the High impact commodities list (HICL) of the Science Based Targets Network (SBTN) [5] – and, together with water use, can be modeled using input-output tables. In the area of land use, there are some initial calculations for the four primary sectors of agriculture, fisheries, forestry and mining on potential production reductions or costs due to resettlement or land restrictions. For water and soil pollution, there are also initial calculations on how political fertilizer and pesticide requirements can affect agricultural production.
A 2020 study by the U.S. Department of Agriculture (USDA) [6], for example, calculates agricultural output and price changes if the following measures were to take effect by 2030: Reduction
- of pesticide use by 50%,
- of fertilizers by 20%,
- of antimicrobial agents in livestock farming by 50% and
- of the agricultural area by 10%
Global implementation of the measures would lead to a reduction in production of over 12% for beef farms, whereby a successful price pass-through would not be expected due to sustainable alternatives. For other products such as rice and wheat, there would be a global price increase of over 100% – in some cases even over 500%. Such a sharp rise in food prices would have far-reaching effects that go beyond agriculture: Food insecurity and potential social unrest could have significant macroeconomic consequences.
In addition to the inclusion of macroeconomic consequences, the microeconomic effects on the primary sectors can also be modeled using downstream analyses for other sectors. The value added of the primary sectors forms the basis of the manufacturing and processing industry and is therefore a central component of most supply chains. Figure 1 shows an approach in which the focus is on transitory risks for the four primary sectors and financial losses for secondary and tertiary sectors are calculated using downstream analyses.
Figure 1: Focusing on primary sectors with subsequent downstream analyses as a conceivable approach to quantifying transitory risks.
The ongoing loss of biodiversity threatens to have a massive impact on our planet and the basis of human life. It is therefore to be expected that regulatory requirements and expectations of companies and financial institutions will continue to rise. In the future, it will be essential for banks to measure and manage the impacts and dependencies of their economic activities on biodiversity and ecosystem services. In order to assess risk exposure as accurately as possible, the disclosure of biodiversity-related information and raw data by the bank’s individual customers will be an essential prerequisite in future. Although there are still many uncertainties from a political perspective and measures to protect biodiversity have so far contained only a few concrete objectives, there are already approaches and possibilities for quantifying parts of the risk.
Looking ahead, it is clear that either developments require much stricter political measures or we are heading for a scenario with potentially serious consequences – in either case, natural risks will become much more significant.
Source list:
[1] European Central Bank, “Interview with Frank Elderson, Member of the Executive Board of the ECB and Vice-Chair of the Supervisory Board of the ECB, conducted by Martin Arnold on 1 June 2023, ” [Online] Available at: Interview with the Financial Times [Zugriff am 11.12.2024]
[2] World Economic Forum, “Global Risk Report 2024, ” [Online] Available at: Global Risks Report 2024 | World Economic Forum | World Economic Forum [Zugriff am 11.12.2024]
[3] ENCORE, “Exploring Natural Capital Opportunities, Risks and Exposure, ” [Online] Available at: ENCORE [Zugriff am 11.12.2024]
[4] Science Based Target Networks, “high impact commodity list (HICL),” [Online] Available at: Assess – Science Based Targets Network [Zugriff am 11.12.2024]
[5] U.S. Department of Agriculture, “Economic and Food Security Impacts of Agricultural Input Reduction Under the European Union Green Deal’s Farm to Fork and Biodiversity Strategies, ” [Online] Available at: USDA ERS – Economic and Food Security Impacts of Agricultural Input Reduction Under the European Union Green Deal’s Farm to Fork and Biodiversity Strategies [Zugriff am 11.12.2024]
