Managing Nature-Related Financial Risks: A Precautionary Policy Approach for Central Banks and Financial Supervisors

37 Pages Posted: 9 Nov 2020

See all articles by Katie Kedward

Katie Kedward

UCL Institute for Innovation and Public Purpose

Josh Ryan-Collins

Institute for Innovation and Public Purpose

Hugues Chenet

University College London - UCL Institute for Sustainable Resources; Chair Energy and Prosperity

Date Written: August 18, 2020

Abstract

This paper considers how financial authorities should react to environmental threats beyond climate change. These include biodiversity loss, water scarcity, ocean acidification, chemical pollution and — as starkly illustrated by the COVID-19 pandemic — zoonotic disease transmission, among others. We first provide an overview of these nature-related financial risks (NRFR) and then show how the financial sector is both exposed to them and contributes to their development via its lending, and via the propagation and amplification of financial shocks. We argue that NRFR — being systemic, endogenous and subject to ‘radical uncertainty’ — cannot be sufficiently managed through ‘market- fixing’ approaches based on information disclosure and quantitative risk estimates. Instead, we propose that financial authorities utilise a ‘precautionary policy approach’, making greater use of qualitative methods of managing risk, to support a controlled regime shift towards more sustainable capital allocation. A starting point would be the identification and exclusion of clearly unsustainable activities (e.g. deforestation), the financing of which should be discouraged via micro- and macro-prudential policy tools. Monetary policy tools, such as asset purchase programmes and collateral operations, as well as central banks’ own funds, should exclude assets linked to such activities.

Keywords: Financial stability, financial regulation, macroprudential policy, central banks, environmental risks, nature-related financial risks, environmental degradation, biodiversity loss, sustainable finance, systemic risk, low carbon transition, climate change, climate-related financial risks

JEL Classification: Q54, Q57, E44, E58, G28, G14

Suggested Citation

Kedward, Katie and Ryan-Collins, Josh and Chenet, Hugues, Managing Nature-Related Financial Risks: A Precautionary Policy Approach for Central Banks and Financial Supervisors (August 18, 2020). Available at SSRN: https://ssrn.com/abstract=3726637 or http://dx.doi.org/10.2139/ssrn.3726637

Katie Kedward (Contact Author)

UCL Institute for Innovation and Public Purpose ( email )

11
Montague Street
London, WC1B 5BP
United Kingdom

Josh Ryan-Collins

Institute for Innovation and Public Purpose ( email )

11
Montague Street
London, WC1B 5BP
United Kingdom

Hugues Chenet

University College London - UCL Institute for Sustainable Resources ( email )

Gower Street
London, WC1E 6BT
United Kingdom

Chair Energy and Prosperity

France

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