Natura finis magistra – recognizing nature’s risks to make finance thrive
Keynote speech by Frank Elderson, Member of the Executive Board of the ECB and Vice-Chairman of the Supervisory Board of the ECB, at the De Nederlandsche Bank/Official Monetary and Financial Institutions Forum conference on the theme “Beyond the climate: integrating the Biodiversity in Financial Markets” at Artis Zoo Amsterdam
Amsterdam, September 29, 2022
The translation of the full Latin name of the Artis zoo, founded in 1838 as “Natura Artis Magistra”, is “Nature is the master of the arts”. Today, nature has something to say to all of us: she is suffering. And we are responsible for this evil. Human activities cause the decline of natural capital, the reduced ability to provide ecosystem services and the loss of biodiversity. Moreover, we are jeopardizing more than half of the world’s GDP. Around 40 trillion euros of global income depends on nature.
This means that nature-related risks, including those associated with biodiversity loss, could have significant macroeconomic implications. Ignoring, mitigating and adapting to these implications is a source of risk for individual financial institutions and for financial stability. In a nutshell, it is part of our mandate, as recognized by the NGFS in its Nature Risk Statement released in March 2022. environmental degradation will expose financial institutions to physical and transitional risks in much the same way as climate change.
Despite this, it must be admitted that central banks, supervisors, regulators and international standards bodies have so far made less progress in integrating environmental risks than climate-related risks. Although the analytical framework for climate-related risks is broadly applicable to environmental risks, these have their own characteristics and challenges. For example, biodiversity does not have a one-size-fits-all metric like carbon dioxide equivalents, which feature prominently in climate discussions. So we have to look at many other parameters, such as nitrogen, phosphorus and carbon dioxide. Let me emphasize “look more”, not “look away”.
Since we have explicitly recognized the materiality of nature-related financial risks, it is no longer a matter of principle that work on environmental risks is less advanced than work on climate. It’s about putting it into practice. And it is clear that we can no longer drag our feet with the implementation. Here, an important contribution will be made by the new NGFS working group on nature risks which will be led by Saskia de Vries from De Nederlandsche Bank and Sylvie Goulard from Banque de France. Both representatives of institutions that have done pioneering work on nature-related risks.
At the ECB, work on environmental risks is already beginning to take shape in our banking supervision. In 2020, we published our guidance on our supervisory expectations for C&E risk management. Indeed, C-and-E: climate and environmental risks. In this guide, we have explicitly recognized that environmental factors linked to the loss of ecosystem services, such as water stress, biodiversity loss and resource scarcity, have also been shown to generate financial risks. We therefore expect banks to assess all information related to environmental risks beyond just climate risks in order to ensure that their risk management is comprehensive.
When we asked banks last year to assess their own risk management practices against our expectations, we found that some of them had already begun to identify and manage risks beyond those which are only related to the climate. However, very few banks at the time had actually started to implement these practices and we made them aware of this deviation from our prudential expectations.
As part of this year’s thematic review on climate and environmental risks, we followed up on these points, focusing on banks’ assessments of the materiality of environmental risks and their risk management frameworks. Our preliminary results show that many banks have now made an initial assessment of their exposure to environmental risks. We also see that banks use the “Climate Risk Playbook” to develop their approach to environmental risk. They map physical and transition risk factors and typically start by excluding certain activities to avoid funding those with excessive environmental impact. Banks are also incorporating these risks into their due diligence processes to gather information and better understand how their customers might be affected. In addition to these qualitative approaches, several institutions are leading the way in quantifying risks and impacts through the use of biodiversity footprint exercises and the development of approaches for biodiversity scores.
We welcome this progress and will take the opportunity to share the best practices we have identified when we publish the results of the thematic review soon. At the same time, we reaffirm that all banks must ultimately comply with all of our prudential C&E risk expectations by the end of 2024 at the latest.
Regarding our monetary policy, the ECB is currently fully on track to implement the climate action plan to which we committed when we presented our new monetary policy strategy in the summer of ‘last year. To give you a concrete example, we announced last week the details of how we intend to gradually decarbonize our holdings of corporate bonds, starting next Monday, in line with the objectives of the Paris Agreement. At the same time, it is important to remember that our climate action plan is not a goal in itself, but rather a means for us to fulfill our mandate. This is why the Governing Council announced in July that it would regularly review the measures proposed in its action plan to assess whether they are still fit for purpose and would continue to support the decarbonisation path towards achieving of the Paris Agreement targets, as well as the EU climate neutrality targets. And not only that. Something that is clearly relevant to us and this conference is that we will adapt these measures as necessary to address other environmental risks within our mandate.
Expressing a willingness to look beyond climate-related risks and address environmental risks is an important first step that I invite all relevant stakeholders to take. This applies to central banks, supervisors, regulators and international standards bodies. Even though current work currently focuses on climate-related risks, our ever-evolving understanding of the materiality of environmental risks and their transmission channels means that these risks must ultimately be factored into everything we do.
Allow me to conclude.
For the first time in 75 years, the Artis Groote Museum – where this conference is being held – reopened its doors this spring. The theme of the museum is that everything is linked: plants, animals, microbes and human beings, all in a precious but delicate harmony. Economics and finance are no different. Taken together, households, businesses, governments and financial institutions form an equally valuable – and sometimes delicate – balance. Our analysis, assessment and policy actions must reflect the fact that nature and the economy are also interconnected and interdependent. In line with a central theme of the important journal Dasgupta on the economics of biodiversity that “humanity is rooted in nature”.
Back to “Natura artis magistra”. Nature is not only the teacher of the arts, it is also the teacher of finance. One might be tempted to paraphrase: “natura finis magistra”. In fact, nature makes finance prosper. This is what ultimately needs to be fully integrated into the work of central banks, supervisors, regulators and international standards bodies, within their mandate. Because nature-related risks are part of our mandate.
Thank you for your attention.