Biodiversity loss and climate change interactions: financial stability implications for central banks and financial supervisors

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Author(s) :
Katie Kedward, Josh Ryan-Collins, and Hugues Chenet

Article published in Climate Policy, 2022.

Financial risks related to climate change and biodiversity loss are currently being addressed in a largely siloed manner. Neglecting their interconnections, however, may lead to ‘blind spots’ and misestimations of systemic financial risk, potentially undermining progress on both climate finance policy and emerging policy on biodiversity-related financial risks (BRFR). In particular, the ‘risk measurement–based’ approach dominating climate finance policy, which is now being taken up to address BRFR, is poorly equipped to address the radical uncertainty that characterises both types of risks. Furthermore, many BRFR may materalise over a more immediate horizon than climate risks. In this paper, we examine how central banks and financial supervisors are approaching the topic of BRFR in relation to climate-related financial risk. We argue that policymakers should focus upon the broader concept of systemic environmental-financial risks to account for the interactions and trade-offs between both domains of biodiversity and climate change. Instead of seeking evidence of financial materiality before acting, focusing on how the financial system is actively facilitating direct drivers of environmental damage offers a way for financial policymakers to assess potential sources of such risks on the basis of information available today. In turn, policy interventions should aim to reduce harmful flows of finance that may lead to the crossing of
dangerous ecological tipping points.

Key policy insights:

  • Financial policymakers need to think beyond siloes, and act on a precautionary basis to manage climate- and biodiversity-related financial risks concurrently.
  • Financial authorities, coordinating with relevant government departments, should define business activities that are most harmful to climate and biodiversity, especially those contributing to ecological tipping points, e.g. activities linked to tropical deforestation, which will damage both domains.
  • To aid transparency and supervisory risk assessment, financial supervisors could require the mandatory disclosure of portfolio composition, risk management, and due diligence procedures relating to the financing of identified harmful activities.
  • Financial regulators could use their toolkits to discourage the financing of such activities, e.g. by applying punitive capital requirements.
  • This approach may require greater coordination between central banks and other government departments to maintain democratic legitimacy and support existing central bank mandates.