The European Central Bank is broadening its supervision of climate and nature-related risks, warning that ecosystem degradation poses material threats to banks, economic growth and financial stability. As physical climate impacts intensify, regulators are
The destruction of nature is rapidly
evolving from an environmental challenge into one of the financial sector's
most complex risk management issues, according to the European Central Bank
(ECB), as supervisors intensify efforts to understand how ecosystem degradation
could affect banks, borrowers and the wider economy.
Frank Elderson, a member of the ECB's
Executive Board and Vice-Chair of its Supervisory Board, has warned that the
decline of natural ecosystems now represents a material threat to financial
stability, with implications stretching across credit risk, inflation, economic
growth and banking resilience.
His comments come as Europe
experiences another summer of record temperatures, drought and destructive
wildfires, highlighting the increasing financial costs associated with
climate-related physical risks.
The ECB has spent several years
embedding climate risk into prudential supervision. It is now expanding that
work beyond carbon emissions and transition risks to examine the economic
consequences of deteriorating "ecosystem services" – the natural
systems that underpin economic activity, including water availability, soil
quality, pollination, forestry, fisheries and flood protection.
"These services are not stable
but they are in rapid decline," Elderson said. "Knowing that
dependency, and knowing those exposures by the banks, we come to the conclusion
that this is relevant."
Unlike individual weather events,
ecosystem degradation develops gradually and often through interconnected
failures that are considerably more difficult to measure.
Water scarcity, biodiversity loss and
declining soil quality can simultaneously affect agriculture, manufacturing,
transport, pharmaceuticals and energy generation, creating multiple channels
through which financial losses may emerge.
Research undertaken by the ECB
demonstrates the scale of that dependence. Around three-quarters of euro area
bank lending to non-financial companies is extended to businesses that rely
heavily on at least one ecosystem service.
The institution has also identified
water-related risks as among the most significant long-term threats to economic
output across the eurozone, with sectors including agriculture, construction,
manufacturing and mining particularly exposed.
Recognising those vulnerabilities,
the ECB is preparing further analysis examining how different pathways of
ecosystem degradation could translate into credit losses for banks.
The work builds on a broader
programme of supervisory expectations that increasingly requires institutions
to identify, measure and manage both climate and nature-related risks alongside
traditional financial risks.
