identify Brazilian firms for which environmental controversies have been recorded, and merge that information with bank loan data from their annual reports.

The key results of this paper are as follows. Brazilian banks have an outstanding credit exposure of BRL 811 billion to non-financial corporates that operate in sectors highly or very highly dependent on one or more ecosystem services. This amount represents 46 percent of the total non-financial corporate loan portfolio and 20 percent of the total credit portfolio, and is slightly tilted to firms that receive government-subsidized resources (so-called earmarked credit). The highest dependence is on the ecosystems that provide climate regulation, ground water and surface water. Based on historical sensitivity of Brazilian banks’ asset quality to macroeconomic conditions (see Vazquez, Tabak, and Souto 2012) and macroeconomic modeling of ecosystem services (World Bank, 2021), the GDP losses associated with the collapse in ecosystem services could translate into a cumulative long-term increase in corporate nonperforming loans (NPLs) in the order of 9 percentage points, other things being equal. Brazilian banks also have an outstanding loan exposure of BRL 254 billion or 15 percent of their corporate portfolio to firms potentially operating in protected areas. Such an exposure could increase to BRL 437 billion (25 percent of the corporate credit portfolio) should conservation gaps close, and to BRL 664 billion (38 percent of the portfolio) should all priority areas become protected.<sup>8</sup> Finally, for the 11 of 143 Brazilian listed firms for which environmental controversies have been recorded, as of December 31, 2019, banks had an outstanding loan exposure of BRL 109 billion (7 percent of the corporate credit portfolio).

To the best our knowledge, this paper is the first to attempt quantifying bank exposures to biodiversity loss in an emerging market and the second to do so in the relevant literature. The only paper we are aware of that explores biodiversity risks for the financial sector is the pioneering work by De Nederlandsche Bank <u>(DNB 2020), the Dutch central bank. DNB (2020)</u> estimates the exposure of Dutch financial institutions ─ banks, insurance companies and pension funds ─ through debt and equity instruments to risks resulting from the loss of biodiversity, both domestically and internationally, and finds that those exposures are material. Dutch financial institutions have invested a total of € 510 billion (36 percent of the total portfolio) in companies that are highly or very highly dependent on one or more ecosystem services, and are therefore exposed to physical risks if one or more of these services are disrupted or lost. Moreover, the Dutch financial sector is exposed to transition risks through € 28 billion in companies that operate in areas that are protected or that might come under protection and € 96 billion invested worldwide in companies involved in environmental controversies. This paper builds upon DNB (2020) and though it more narrowly focuses on banks and their domestic exposures to biodiversity loss through lending activities, it extends DNB (2020) in two directions. First, this paper estimates the impact on Brazilian bank NPLs of the loss of ecosystem services. Second, it measures transition risks by relying on the Brazilian government’s plans with regard to biodiversity conservation areas, as opposed to scenarios for the expansion of protected areas.

> 8 Conservation gaps refers to those areas which are not currently protected and are classified as areas of very high priority actions for biodiversity conservation.

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