Economic instability looms as deforestation progresses
In recent years, the world has witnessed an increasing awareness among central banks and financial supervisors regarding the potential risks posed by deforestation. This shift in focus comes as important forest biomes, such as the Amazon, approach tipping points that could have far-reaching consequences for regional and global rainfall patterns, forest fire rates, and the status of the Amazon as a carbon sink.
Climate change has received considerable attention in the context of global financial regulation, but nature degradation, particularly forest loss, has been relatively underserved. Financial institutions are already disclosing some information related to water, and calling for disclosure of deforestation risks is seen as a crucial step in closing the information gap that allows these risks to go unpriced.
The interest in assessing and addressing nature degradation risks, including deforestation, has grown significantly. Central banks are recognising that environmental disruptions can complicate inflation management and become more relevant as extreme events intensify and ecological buffers like forests and wetlands are eroded.
One such central bank leading the charge is Brazil's, which has incorporated deforestation indicators into its monitoring framework. The European Central Bank is also assessing biodiversity loss as a potential source of systemic risk, and the Bank of England has included indicators of deforestation in its monitoring frameworks.
Central banks could further incorporate deforestation into their economic assessments where relevant, as forest loss and degradation can affect prices and output. They could also require financial institutions to disclose litigation exposure linked to environmental risks such as illegal deforestation.
Financial supervisors could integrate forest risks into stress testing and scenario analysis, building on the knowledge and tools developed for climate risk. Central banks and financial supervisors could lead by example to spur action among financial sector participants, by assessing their own portfolio exposure to deforestation and embedding ecological risk in asset purchases and transition planning.
Forests provide a multitude of functions that support societal and economic wellbeing. However, they are under severe threat, with primary forests disappearing at a rate of 3.5 million hectares per year. Deforestation can lead to economic consequences, such as degrading soil quality, reducing agricultural sustainability, disrupting pollinator habitats, increasing the risk of plant and human diseases, and amplifying the impacts of extreme weather events like floods and landslides.
Last year's floods in Brazil's Rio Grande do Sul serve as a stark reminder of how deforestation can contribute to short-term food price pressures. Weak currencies and high borrowing costs make it difficult for forest-rich countries to attract long-term sustainable investment.
The 2030 target to halt deforestation was set at Cop26, not by the Convention on Biological Diversity. This underscores the urgent need for concerted action from all sectors, including the financial sector, to address this critical issue. Central banks and financial supervisors are poised to play a significant role in this effort.
In conclusion, the recognition and addressing of deforestation risks by central banks and financial supervisors represent a significant step forward in the global fight against deforestation. By incorporating these risks into their operations and encouraging disclosure, they can help drive sustainable investment, protect vital ecosystems, and safeguard the wellbeing of future generations.
