production of commodities linked to forest destruction (which exceed by a factor of 100 or more the amount spent on measures to combat deforestation) and the deforestation rate, with improvements in the Amazon biome being undone in recent years (CBD 2020).<sup>6</sup> It is expected that new targets will be committed following the UN Convention on Biological Diversity (CBD) in October 2021 (COP15), which has the objective of increasing the extent of protected areas, promoting the sustainable use of ecosystems and lessening the causes of biodiversity loss.

Given the potentially significant macrofinancial implications of biodiversity loss in Brazil, it is important that both banks and Banco Central do Brasil (BCB), the central bank, build the capacity to understand and in time manage the risks associated with the loss of biodiversity. As the Dasgupta Review of the Economics of Biodiversity notes, the “financial system is critical to supporting a more sustainable engagement with nature” (Dasgupta 2021). Brazil’s financial system is bank-based, with banks’ assets accounting for about two-thirds of total financial system assets. Therefore, banks can play a pivotal role in managing and mitigating the risks and uncertainty resulting from the unsustainable engagement with nature. At the same time, BCB, within its mandate to ensure a solid and efficient financial system, has an interest that banks address nature-related risks adequately and proactively, learning and building on the advances on climate-related financial risks. Leveraging on its participation in the Central Banks and Supervisors Network for Greening the Financial System (NGFS), BCB is implementing a sustainability agenda as a part of its institutional work program, which could give renewed emphasis to nature-related financial risks.<sup>7</sup> This paper explores how and to what extent Brazilian banks are exposed to the loss of biodiversity through their lending to non-financial corporates. First, we describe the extent to which the banking sector is indirectly dependent on ecosystem services, which is our proxy for physical risks. Using the ENCORE database, which details and assigns a score on the dependencies on 21 ecosystem services for 86 business processes, we link the latter with economic sectors and then we determine bank credit exposures to those sectors using BCB data. This gives us evidence of Brazilian banks’ exposure to sectors that are highly or very highly dependent on one or more ecosystem services. Second, we describe the extent to which Brazilian banks finance companies that potentially operate in protected areas and priority areas for biodiversity conservation, and that are involved in environmentally controversial activities. This is the proxy we use to measure transition risks. Based on _Relação Anual de Informações Sociais_ (RAIS) and BCB data, we first map bank loan exposures at the municipal level. In a further step, we merge those geographical exposures with data from the World Database on Protected Areas and the Brazilian Ministry of Environment to determine banking sector loans to companies in protected or priority areas as determined by the Brazilian authorities. Finally, we use the MSCI ESG Controversies database to

> 6 According to country’s national space research agency INPE, in the first half of 2020 deforestation was up 25 percent, for a total 1,184 square miles, compared to the same period in 2019, on track to be the worst year for deforestation in more than a decade. See http://www.inpe.br.

> 7 See https://www.bcb.gov.br/en/financialstability/sustainability.

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