Deforestation endangers financial security
The global fight against deforestation has taken a significant turn, with central banks around the world starting to acknowledge the financial risks associated with the destruction of forest ecosystems.
At the COP26 summit, the 2030 target to halt deforestation was set, marking a crucial milestone in the battle to preserve the world's forests. However, it's important to note that this target was not set by the Convention on Biological Diversity, but rather by the international community at the climate conference.
Primary forests are disappearing at an alarming rate of 3.5 million hectares per year, a loss that not only impacts biodiversity but also threatens the ecosystem services these forests provide, such as climate regulation, water security, and disaster risk reduction.
Forest-rich countries face challenging trade-offs between resource-driven exports and maintaining ecological stability. This dilemma is further exacerbated by the flow of capital from advanced economies into sectors directly linked to deforestation, with limited assessments of systemic risks.
Recognising the urgency of the situation, central banks are stepping up to lead by example. They are assessing their own portfolio exposure to deforestation and are interested in monitoring deforestation because it poses financial risks related to environmental damage, regulatory changes, and market disruptions.
Central banks play a role by integrating deforestation-related risks into their financial stability assessments and guiding sustainable investment practices. They can encourage the disclosure of nature-related risks, including on deforestation-linked activities.
The European Central Bank is already assessing biodiversity loss as a potential source of systemic risk, and financial supervisors could integrate forest risks into stress testing and scenario analysis. Central banks can also require financial institutions to disclose litigation exposure linked to environmental risks such as illegal deforestation.
Global governance mechanisms for forests are currently lacking, despite ambitious targets such as halting deforestation by 2030. Central banks can contribute to systemic change within the financial system by recognising that ecological integrity is a precondition for economic and financial stability.
Moreover, forests cover 31% of the Earth's land surface and support 80% of terrestrial biodiversity. As forest ecosystems degrade, the services they provide are compromised with cascading effects across sectors. Over the past decade, nature degradation, particularly forest loss, has been underexplored in the context of global financial regulation.
Financial institutions are already disclosing some information on water, and central banks can call for disclosure of deforestation risks in a similar manner. Deforestation can generate physical risks such as floods, fires, and droughts, and transition risks including regulatory changes, consumer preferences, and legal challenges.
The Amazon, one of the world's most important biomes, is under severe threat, nearing irreversible tipping points. The battle to save the Amazon and other threatened forest ecosystems is not just an environmental issue; it's a financial one as well. With central banks taking a stand against deforestation, we might just be on the brink of a new era of financial regulation that prioritises the health of our planet.
