Central authorities should curb the deterioration of the natural environment
In the face of the mounting shocks of the nature and climate crisis, central banks and financial supervisors worldwide are leveraging their powers to safeguard the financial system. Through monetary policy, supervision, and regulation, these institutions aim to create a more resilient economy that can withstand the devastating consequences of environmental disruption.
The implications of inaction are stark. For instance, severe drought in Hungary could potentially double the volume of non-performing loans, increase sovereign debt, and reduce economic output by 4-7% in a single year without adequate mitigation strategies. Similarly, environmental degradation in the United Kingdom could cause a 12% contraction in GDP if left unchecked.
Fortunately, central banks have a robust arsenal of tools to combat these risks. They can set limits on investment exposure to assets or sectors that are particularly vulnerable to nature- and climate-related risks. Additionally, they can give preferential treatment to more resilient and adaptive green assets and sectoral strategies in their collateralisation frameworks and targeted refinancing operations.
The Financial Stability Board, the Bank of England, the European Central Bank, the Federal Reserve, and others have been proactive in integrating climate and nature risks into financial regulations and stress testing. This initiative promotes transparency and resilience by developing frameworks, guidelines, and supervisory expectations.
However, the growing body of evidence linking nature degradation and climate change to price stability and the financial system is at odds with the current political zeitgeist, particularly in the United States under the administration of Donald Trump. The rise of climate denialism on both sides of the Atlantic has pushed ambitious action to protect the financial system from nature- and climate-related shocks off the agenda for now.
Despite these challenges, central banks and supervisors can require commercial banks and insurers to assess, report on, and stress-test their portfolios for nature- and climate-related risks and dependencies. This proactive approach will help to prevent macroeconomic instability and move the economy towards one that is better protected against the mounting shocks of the nature and climate crisis.
Julie McCarthy, CEO of NatureFinance, emphasizes the importance of this work. "All central banks need to do is fulfill their financial-stability mandate to protect the financial system from nature- and climate-related shocks," she says.
In 2024, extreme weather events affected multiple countries, including China, Germany, Kenya, India, Brazil, the United States, and Ghana. The year was also the hottest on record, costing over $229 billion in climate disasters. As the world continues to grapple with these challenges, the role of central banks and financial supervisors in promoting a more sustainable and resilient economy becomes increasingly crucial.
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