A common way to assess banks’ nature-related physical risk is to consider the system-wide loan portfolio allocation to different economic sectors, which depend to varying degrees on ecosystem services. Following van Toor et al. (2020) and Calice et al. (2021), this analysis uses the ENCORE database, which provides a list of 86 business processes that directly depend on 21 ecosystem services - 17 regulation and maintenance ecosystem services and 4 provision services (see Table 3).<sup>3,4</sup> ENCORE links economic activities to the dependencies they potentially have on ecosystem services and the impacts they potentially have on natural capital. This enables a detailed assessment of the interactions of the economy with the natural environment, which in turn allows assessing the banking sector’s exposure to potential nature-related physical risks.

We use publicly available country-level data on bank credit to non-financial firms as of end-2020, typically provided by central banks. We built a database of those credit portfolios by economic sectors for a set of 20 emerging and frontier markets (see Table 1).<sup>5</sup> Using the World Bank income-based country classification, the sample consists of 6 lower-middle-income, 8 upper-middle-income, and 6 high-income countries; accounting for around 10 percent of global GDP (Figure 1).<sup>6</sup> In order to link credit information with ecosystem service dependency, we first connect sectoral lending portfolios to the production processes that underlie each economic sector. We map economic sectors to production processes using the crosswalk between NACE (Rev.2)<sup>7</sup> and the production processes rated in ENCORE, which are grounded on GICS<sup>8</sup> developed by the UN Environment Programme World Conservation Monitoring Centre (UNEP-WCMC, developers of ENCORE). In case of multiple production processes linked to an economic sector, we apply equal weighting to match NACE economic sectors and GICS production processes. For countries in our sample that do not publish sectoral credit portfolio statistics according to the NACE classification, we rely on standard correspondence tables published by Eurostat to facilitate the mapping.<sup>9</sup> Given the wide range of countries, publicly reported data granularity 3 The ecosystem services dependencies materiality ratings by ENCORE are based on literature reviews carried out for each ecosystem service class and production process combination using Web of Science, Google and key document searches (e.g.: TEEB for Business, leading companies in the sector and industry initiatives). Expert interviews were conducted with sector specialists to validate information or to address data gaps for some sectors or production processes. For additional details see <u>https://encore.naturalcapital.finance/en/data-andmethodology/methodology.</u> 4 To avoid double counting, ENCORE only lists direct potential dependencies and impacts of production processes on ecosystem services. That means that it does not account for impacts that occur through the supply chain.

5 MSCI defines a list of emerging and frontier markets which is more extensive than our set of countries. However, data availability allowed us to analyze a limited number of countries only. To leverage highly granular data available for developing countries not included in MSCI’s referenced list and to broaden the scope of the paper, we added countries (e.g., Honduras).

6 The World Bank methodology uses gross national income (GNI) per capita data in U.S. dollars, converted from local currency using the World Bank Atlas method, which is applied to smooth exchange rate fluctuations.

7 NACE (Nomenclature of Economic Activities) is the classification of economic activities in the European Union (EU). Its latest revision (Rev.2) was performed in 2008.

8 Global Industry Classification Standard (GICS), a classification developed by a private data provider.

9 See Eurostat - Reference and Management of Nomenclatures – Index of Correspondence Tables. Available at: <u>https://ec.europa.eu/eurostat/ramon/index.cfm</u> 4