Biodiversity Risks Are Difficult for Banks to Quantify

Biodiversity risks are much more difficult for financial service providers to identify in their risk management than, for example, the dangers posed by climate change. Yet the loss of biodiversity can have a direct impact on institutions. However, suitable metrics, evaluation procedures and, above all, data are lacking. These gaps need to be closed.

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“Reporting on biodiversity, ecosystems and their services plays a central role within the EU CSRD and its ESRS,“ states Tobias M. Wildner in the german open access book "The Future of Economic Reporting".

Other reporting standards and regulations, on the other hand, usually focus only on specific aspects. In doing so, the economy and society exert influence on ecosystems and species and, in turn, depend on corresponding ecosystem services.

A Functioning Economy Needs Biodiversity

“The biodiversity crisis is one of the greatest challenges of our time,” postulates Heiko Bailer, Head of Quantitative Investments at LBBW Asset Management, in a recent commentary on the 29th UN Climate Change Conference (COP29). Because without a balanced biodiversity, a functioning global economy is ‘unthinkable in the long term’. In Germany alone, the fact check on biodiversity this year showed that one third of animal and plant species are endangered. The solution to the biodiversity crisis is also urgent not least because it has a major economic component. “50 percent of the world's gross domestic product depends directly or indirectly on natural capital,” said Bailer. If this crisis is not resolved, “global growth could be reduced by 2.3 percent per year or the equivalent of 2.7 trillion US dollars by 2030 as a result of this alone”.

The main causes are changes to the Earth's surface, the exploitation of animals and plants, climate change, pollution and invasive species. However, nature performs essential functions that we cannot do without: It stores water, regulates the climate and binds CO_2. Since these services are not offset by any real costs, their economic value is often underestimated. An estimated 50 percent of global GDP (€40 trillion annually) is moderately to heavily dependent on nature. On the other hand, between 700 and 1,000 billion US dollars would be needed annually to preserve biodiversity. A comparatively small sum in view of the high benefits”

,write the economists at Landesbank Baden-Württemberg (LBBW) in a special report on this year's climate conference in the Azerbaijani capital Baku.

Loss of Biodiversity Continues

The reality of the risks is shown by data from the World Conservation Union (IUCN). According to this data, of the 147,500 animal and plant species recorded, almost 41,500 are in threat categories. And these figures from summer 2022 are likely to have increased even further by now. According to the WWF, species extinction is considered the greatest threat to the planet, alongside the climate crisis. As the World Economic Forum reports in its “Global Risk Report 2024,” the loss of biodiversity and the collapse of ecosystems ranks third among the greatest economic risks over the next decade, behind extreme weather events and critical changes to the Earth's systems.

Financial companies are also confronted with the loss of biodiversity. Regulators are requiring banks to integrate biodiversity risks in a similar way to climate risks. A survey by the consulting firm KPMG shows that almost 70 percent of global financial institutions rate this complex of risks as equally significant or even more significant than the consequences of climate change.

One example is financing in the construction industry: “The EU taxonomy defines sustainability standards for investments that are in line with the climate targets set,” writes Christian Grabmair in the german book "Kreditprozessmanagement" (loan process management).

In addition to energy efficiency, criteria for sustainable water use, the transition to a circular economy, pollution prevention and the protection of biodiversity are also included in new buildings.

Reliable Data and Assessment Processes are Lacking

“The large number of variables, the lack of meaningful data and the novelty of the topic pose particular challenges for banks,” according to a market commentary by KPMG from September on the topic. This is because the recording and management of biodiversity risks - for example in the context of investments or financing - is complex.

There is a lack of comprehensible and simple metrics, such as those provided by CO₂ emissions to determine possible climate change. This makes a clear and consistent assessment difficult. There is a lack of continuous data collection and precise scenarios to understand the complex interactions of biodiversity risks and to integrate them into risk management in a structured way.

Closing Gaps in Risk Strategies

In order to close the gaps in risk strategies, financial service providers should take action in five key areas:

1. Definition and structuring: Banks should start by developing clear definitions and categories for biodiversity risks. Identifying and sorting relevant risk drivers is crucial to making the complex issue manageable and to integrating the loss of biodiversity into risk management in a targeted manner.
2. Development and application of specific assessment metrics: Since biodiversity risks cannot be measured by a single clear indicator, institutions should work with industry-specific organizations to develop suitable, location-based measurement methods and data sources. This could also mean using synergetic approaches that combine existing climate data with biodiversity-relevant information.
3. Extending risk assessment to the loan portfolio: In line with climate strategy, the direct loan portfolio should be examined for biodiversity risks. Physical and transitory risks, as well as reputational risks, should be taken into account. To do this, banks should obtain relevant information from customers and include it in their assessment.
4. Development of a data-based infrastructure: Since the data situation is often still incomplete, banks should invest in appropriate infrastructures. Cooperating with environmental organizations and scientific institutes is also a useful way of gathering reliable information. The aim is to continuously improve data on ecosystems and biodiversity and thus create a reliable basis for risk assessments. Standards can help to integrate this data into existing risk management systems.
5. Taking regulatory requirements into account and preparing for future requirements: In view of increasing regulatory requirements, financial institutions should proactively integrate biodiversity into their strategies and prepare for future requirements. By establishing an appropriate governance structure that takes biodiversity risks just as seriously as climate risks, companies improve their risk and reputation profiles in the long term.