SPEECH

Taking account of nature, naturally

Speech by Frank Elderson, Member of the Executive Board of the
ECB and Vice-Chair of the Supervisory Board of the ECB, at the
tenth Green Finance Forum "Innovate in Nature"

Frankfurt am Main, 19 November 2024

Thank you for inviting me to speak at the opening of the tenth Green Finance Forum. I fully subscribe
to the theme of today's forum, given how vitally important it is to "innovate in nature". Especially
because in many ways nature is still not accounted for in policies, regulation and risk management,
but it should be, considering its vital importance for the economy - including the financial system. This
morning I will outline how the relevance of nature is being confirmed by incoming research and how
the European Central Bank (ECB) is acting on this to deliver on its mandate of maintaining price
stability and preserving the safety and soundness of banks.

A thriving natural environment provides many benefits that sustain human well-being and the global
economy. Think of fertile soils, pollination, timber, fishing stocks, clean water and clean air.
Unfortunately, intensive land use, climate change, pollution, overexploitation and other human
pressures are rapidly and seriously damaging our natural resources. The Intergovernmental Science-
Policy Platform on Biodiversity and Ecosystem Services already sounded the alarm back in 2019,

shortly before the outbreak of the pandemic."] The degradation of nature is primarily caused by
human activity and is being made worse by global heating. In addition to the depletion of non-
renewable resources, natural inputs to the economy that are renewable are also increasingly being
degraded. Scientists have calculated that humanity is using natural resources 1.7 times faster than
ecosystems can regenerate them - in other words, we are consuming resources equivalent to 1.7
planet Earths.

This nature loss poses a serious risk to humanity as it threatens vital areas, such as the supply of food
and medicine. Such threats are also existential for the economy and the financial system, as our

economy cannot exist without nature.!2! One of the papers presented at the annual ECB Forum on
Central Banking in Sintra, Portugal, in July of this year shows how biodiversity loss can cause losses
to economic output while at the same time decreasing the resilience of that output to future biodiversity

losses. However, in practice, at least thus far, the contribution of the inputs nature provides to the
economy is rarely measured directly in statistics like GDP.

Central banks and supervisors like the ECB need to gain a better understanding of just how vulnerable
the economy and the financial system are to nature degradation. We need to incorporate nature into
the analysis of the drivers of economic development and the assessment of future productive capacity.

4] Degradation of nature can impair production processes and consequently weaken the

creditworthiness of many companies, which might in turn impair loans extended by banks.

How nature affects the economy

As is the case with climate change, nature affects companies and banks via two main channels:
physical risks and transition risks. Physical risks may be acute risks, such as increasingly severe
natural disasters, or chronic risks, such as dwindling ecosystems. The effects could include falling crop
yields owing to a decline in pollinating insects or the degradation of agricultural land. The scarcity of
natural products could lead to supply-side shocks for the pharmaceutical industry or make some

tourist destinations less attractive.

Nature loss can also amplify the t ansition risks of banks and their borrowers. Governments are
stepping up their efforts to protect the environment: the UN Convention on Biological Diversity set
global targets in 2022, including the conservation by 2030 of at least 30% of the world's lands, inland

waters, coastal areas and oceans.!©! Such government measures could lead to changes in regulation
and policy, limiting the exploitation of natural resources or banning certain environmentally harmful
products. Technological innovation, new business models and changes in consumer or investor
sentiment could also lead to transition risks and transition costs as companies are forced to adapt.
Some established business models could disappear, while others might become too expensive and
lose market share.

At the ECB, we looked at the dependence on nature of more than 4.2 million individual companies

accounting for over €4.2 trillion in corporate loans. We assessed how dependent companies and
banks in the euro area are on the various benefits that humanity obtains from nature - experts call this
concept "ecosystem services". Examples of the services that ecosystems provide are products such
as food, drinking water, timber and minerals; protection against natural hazards; and carbon uptake

and storage by vegetation.

To assess the associated physical risk, we assessed the extent to which companies financed by euro
area banks are dependent on ecosystem services. The principal assumption behind this assessment
is that greater dependence on ecosystem services is likely to result in greater exposure to ecosystem
degradation. If nature degradation continues, economic activities dependent on ecosystem services
will be affected by issues such as supply chain disruptions, which have an impact on prices and
ultimately on inflation. Moreover, reduced turnover could result in defaults and, as a consequence,
losses for the banks that lend to these companies. This could ultimately lead to financial stability

concerns.

Our analysis shows that euro area companies are significantly exposed to several ecosystem
services, both directly and via their supply chains. The most important services are mass stabilisation
and erosion control, surface and ground water supply, flood and storm protection, and carbon uptake
and storage. Indirect dependency via supply chains is particularly significant for sectors such as
agriculture, manufacturing and wholesale, and the retail trade.

Our assessment shows that in the euro area, around three million individual companies are highly
dependent on at least one ecosystem service. Severe losses of functionality in the relevant ecosystem
would translate into critical economic problems for those companies. We also found that almost 75%
of bank loans to companies in the euro area are granted to companies that are highly dependent on at
least one ecosystem service. We observed only moderate differences between countries, as indirect

supply chain dependencies offset smaller direct dependencies, especially in small and open

economies.

Accounting for nature in central banking and supervision

The results of our research confirm that the European economy is highly dependent on ecosystem
services and that these risks can spread to the financial system, potentially triggering instability. If
nature degradation continues at its current pace, companies will be affected and banks' credit
portfolios will deteriorate. This is why we expect banks under our supervision to manage all material
nature-related risks, consistent with the supervisory guide that we published in 2020 with expectations

about banks' risk management practices for both climate-related and environmental risks. It is also
the reason the ECB has made nature one of the focus areas of its climate and nature plan for 2024
and 2025.

Our ongoing work confirms the profound impact of nature degradation on the economy, including the
financial system and price stability, which mirrors that of climate change. Nature degradation and
climate change are therefore both relevant to our mandate and our monetary policy strategy. From my
point of view, the ECB's upcoming assessment of the monetary policy strategy provides an opportunity
to confirm the relevance of nature degradation and climate change for monetary policy in the euro

area.

An integrated approach to climate and nature is critical, because they are interconnected and amplify
the effects of physical and transition risks. Given the high level of uncertainty regarding impacts, non-
linearities, tipping points and irreversibility, gauging nature-related risks is complex. We cannot do this
alone. Scientific input is needed to learn more about the transmission channels to our economies.

Work is progressing at the international level. The Network for Greening the Financial System (NGFS)
- a network of 141 central banks and supervisors from around the world - had already acknowledged

the relevance of nature-related risks to the mandates of these institutions back in March 2022.[8! The
NGFS has since developed a conceptual framework offering central banks and supervisors a common

understanding of nature-related financial risks and a principle-based risk assessment approach.

Moreover, in July this year the NGFS published a report on nature-related litigation to raise awareness

among financial institutions, central banks and supervisors.) The report highlighted that while
nature-related litigation is still in its infancy, the number of cases is expected to grow rapidly. This trend
underlines the real risk of doing too little: for governments, companies, banks, central banks and
supervisors.

Policymakers, regulators and supervisors are in fact taking action. The Financial Stability Board
recently took stock of supervisory and regulatory initiatives among its members and established that a
growing number of financial authorities are considering the potential implications nature-related risks

have for the financial sector" This work must continue. International fora must ensure that nature-
related considerations are fully integrated into regulation and supervision, alongside ongoing efforts to
account for climate-related considerations. This starts with identifying exposures and vulnerabilities to
nature-related risks. This does not mean that economists should start counting ants in Aragon,
butterflies in Bavaria or worms in Wallonia. Instead, economists must develop the means to transpose

insights from environmental science into variables of economic interest like growth, inflation and
financial risks.

Since our economy relies on nature, destroying nature means destroying the economy. Preventing the
destruction of nature is the responsibility of elected governments, as they are the ones who make
environmental policies. For their part, central banks and supervisors have to take nature-related risks
into account in the pursuit of their mandates, just as they do with any other factors that are vitally
important to price stability and the safety and soundness of banks. Naturally, at the ECB we are

committed to doing exactly that. Naturally, within our mandate. Naturally, because of our mandate.

1.

Diaz, S., et al. (eds.) (2019), The global assessment report on biodiversity and ecosystem services -

summary for policymakers, Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem
Services, Bonn, Germany.

2.
Dasgupta, P. (2021), The Economics of Biodiversity: The Dasgupta Review, HM Treasury, London.

3.

Kuchler, T. et al. (2024), "The economics of biodiversity loss", paper presented at the ECB Forum on
Central Banking, June.

4.

Martins Cardoso, M. and Parker, M. (2024), "Accounting for nature in euro area economic activity",

Economic Bulletin, Ilssue 6, ECB.

5.
Convention on Biological Diversity (2022), "Nations Adopt Four Goals, 23 Targets for 2030 in

Landmark UN Biodiversity Agreement", press release, Montreal, 19 December.

6.
Boldrini, S., Ceglar, A., Lelli, C., Parisi, L. and Heemskerk, I. (2023), "Living in a world of disappearing

nature: physical risk and the implications for financial stability", Occasional Paper Series, No 333,

ECB.

7.

ECB (2020), Guide on climate-related and environmental risks, November.

8.

NGFS (2022), "NGFS acknowledges that nature-related risks could have significant macroeconomic

and financial implications", press release, 24 March.

9.

NGFS (2024), Nature-related Financial Risks: a Conceptual Framework to guide Action by Central

Banks and Supervisors, July.

10.

NGFS (2024), Nature-related litigation: emerging_trends and lessons learned from climate-related
litigation, July.

11.

Financial Stability Board (2024), Stocktake on Nature-related risks: Supervisory and regulatory