Forests are more than carbon sinks or biodiversity hotspots – they provide a multitude of functions, or ecosystem services, that support societal and economic wellbeing. Over the past decade, climate change has commanded increasing attention from central banks and financial supervisors but nature degradation – and forest loss in particular – is still underexplored in the context of global financial regulation.
However, researchers and policymakers are beginning to understand how forest collapse threatens both progress towards climate goals and the foundational conditions for economic stability, productivity and public health, all of which can cascade across economies through interconnected supply chains.
Forests cover 31% of the Earth’s land surface and support 80% of terrestrial biodiversity. They regulate rainfall, stabilise soils, reduce disease outbreaks and protect against floods and landslides. However, forest ecosystems are under severe threat with primary forests disappearing at a rate of 3.5mn hectares per year, an area the size of Taiwan.
Important forest biomes like the Amazon may be nearing irreversible tipping points that could alter regional and global rainfall patterns, increase the rate of forest fires and transform the Amazon forest from carbon sink to a net emitter.
Economic and financial pressures driving deforestation
Despite this, deforestation remains largely underpriced and underregulated.
At the economic level, deforestation is incentivised. An underlying driver of forest loss is an economic model that relies upon the extraction of natural resources, particularly through sectors such as agriculture, logging, mining and infrastructure. This is currently left unchecked due to a lack of global governance mechanisms for forests, despite ambitious targets such as halting deforestation by 2030 which was agreed at Cop26 in 2021.
Key governance challenges include the lack of a clear, universally accepted definition of what constitutes a forest, and the fact that voluntary initiatives are often undermined by inconsistent regulation, profit maximisation strategies or elite capture. These challenges are compounded by the non-legally binding characteristic of many forest agreements which lack enforcement mechanisms and fail to translate into domestic law.
As a result, fragmented definitions, poor accountability, and competing political interests continue to obstruct coordinated efforts to protect forests at scale.
Meanwhile, at the financial level capital, mostly from advanced economies, continues to flow into sectors directly linked to deforestation with limited assessments of their exposures to, or accounting for, systemic risks.
Forest-rich countries, mostly in low- and middle-income economies, face difficult trade-offs between resource-driven exports and maintaining ecological stability. Weak currencies and high borrowing costs make it difficult for these nations to attract long-term sustainable investment. Notwithstanding, domestic markets are also critical: in Brazil, 80% of beef production stays within the country.
Why should central banks care?
The degradation of nature, including deforestation, can generate physical risks such floods, fires, and droughts, as well as transition risks including regulatory changes, consumer preferences and legal challenges. Deforestation also often precedes the materialisation of climate physical impacts as natural barriers against storms, floods and landslides are eroded.
For financial institutions with exposures to deforestation-linked activities, these can affect traditional risk categories such as credit, liquidity and market risks. So far, however, these risks are largely absent in policy frameworks. Climate scenario-based stress testing frameworks ignore nature degradation, prudential regulation rarely accounts explicitly for deforestation and macroeconomic models typically exclude ecosystem services.
There are already examples of how deforestation has led to economic consequences. For example, land use change including deforestation, can degrade soil quality and reduce agricultural sustainability. It can also disrupt habitats for pollinators resulting in lower crop yields, and increase the risk of plant and human diseases such as malaria in the zones where forests and agricultural areas sit side by side.
Moreover, there is a strong link between deforestation and heightened risks of flooding and landslides. Last year’s floods in Brazil’s Rio Grande do Sul illustrate how deforestation can amplify the impacts of extreme weather. Heavy rainfall affected 90% of the state, displacing over 80,000 people, damaging critical infrastructure such as roads, storage facilities and the main airport, as well as destroying livestock, grain storage sites and agricultural output. These impacts had widespread effects on agricultural supply chains and contributed to short-term food price pressures.
While the monetary tightening conducted by Banco Central do Brasil in September 2024 was primarily in response to persistent national inflation, a positive output gap and rising inflation expectations, the floods may have also contributed to inflation and hence underscore how nature degradation can drive supply-side shocks with inflationary consequences.
Although not explicitly cited in the monetary policy decision, such environmental disruptions can complicate inflation management and may become more relevant for central banks as extreme events intensify and ecological buffers like forests and wetlands are eroded.
This event also offers an important insight into the asymmetrical distribution of costs and benefits of deforestation. While large agribusinesses often reap short-term profits from deforestation and land-use change, the public sector bears the mounting costs of degraded ecosystem resilience through increased public spending on disaster response, healthcare, reconstruction of damaged infrastructure, and climate adaptation measures such as flood defences.
These unplanned expenditures put upward pressure on public debt and can weaken fiscal space, particularly in emerging markets where debt sustainability is already strained. Over time, higher debt levels may limit the effectiveness of monetary policy transmission, raise risk premiums and reduce the policy space within which central banks can respond to shocks.
While environmental protection is primarily the responsibility of governments, nature degradation increasingly presents risks that are macro-critical, affecting inflation dynamics, output volatility and financial stability.
Central banks and financial supervisors therefore have a clear interest in assessing and addressing these risks. Nature-related shocks may build up gradually, but their materialisation can be sudden and destabilising, undermining the conditions under which monetary and financial policy operates.
What can central banks do?
A few central banks are already showcasing what early steps could look like: Brazil’s central bank has incorporated deforestation indicators into its monitoring framework, and the European Central Bank is assessing biodiversity loss as a potential source of systemic risk. But given the pace and scale of environmental degradation, more systematic action is needed.
First, central banks could incorporate deforestation into economic assessments where relevant. Forest loss and degradation can affect prices and output so central banks would have to explore the relevance of incorporating ecosystem dependencies into their economic analysis.
Moreover, financial supervisors could integrate forest risks into stress testing and scenario analysis, building on the knowledge and tools developed for climate risk and adapting them to address nature-related risks. However, tools must be developed to account for the added complexity of the non-linear impacts associated with nature degradation and potential tipping points or regime shifts.
Second, central banks and financial supervisors play a crucial role in providing sound economic assessments and guiding finance within the economy. In many jurisdictions, they are also advisors to governments and (particularly in emerging markets and developing economies) also contribute knowledge building in the financial sector. This role means they could lead by example to spur action among financial sector participants, including by assessing their own portfolio exposure to deforestation and embed ecological risk in asset purchases and transition planning.
Taking one step further, they could also contribute to systemic change within the financial system and international financial architecture by recognising that ecological integrity is a precondition for economic and financial stability. This is already increasingly understood in the context of climate change, but the ecological system is interconnected and climate is only one piece of the puzzle.
Finally, central banks can encourage the disclosure of nature-related risks, including on deforestation-linked activities. Financial institutions are already disclosing some of this information, particularly relating to water, and calling for disclosure of deforestation risks will help close the information gap that allows deforestation risks to go unpriced.
This should also include requiring financial institutions to disclose litigation exposure linked to environmental risks such as illegal deforestation (eg under IFRS or Basel Pillar 3), particularly for sectors or geographies with outsized exposures.
In the context of climate change and growing ecological instability, it is becoming less tenable to view forests as irrelevant to monetary, prudential and financial policy. While the empirical base is still developing, there is growing recognition that deforestation may pose material risks with potential implications for economic and financial stability.
As forest ecosystems degrade, the services they provide – such as climate regulation, water security, and disaster risk reduction – are compromised with cascading effects across sectors including agriculture, infrastructure and public health, and also spill across borders.
In light of these interconnections, central banks and financial supervisors will need to consider how existing tools and frameworks could evolve to better account for nature-related risks, including those associated with deforestation. Taking steps in this direction could support efforts to safeguard financial and price stability over the medium term, in line with core central bank mandates.
Update, 19 August 2025: this article was updated to correct the 2030 target to halt deforestation, which was set at Cop26 and not by the Convention on Biological Diversity.
This page was last updated August 19, 2025
Written by
Elena Almeida is a senior policy fellow at the Grantham Research Institute at the London School of Economics, specialising in nature-related financial risks and central banking.
Elena has also been involved in developing the NGFS Nature Task Force’s Conceptual Framework. Previously, Elena worked on monetary policy at the Central Bank of Malaysia and sustainable finance at the UK Foreign, Commonwealth and Development Office. She has also worked as a climate advisor at the Bank of England, leading the central bank’s work on nature.
