An Exploration of Nature-Related Financial Risks in Malaysia

This joint report from Bank Negara Malaysia (BNM) and the World Bank assesses the exposure of Malaysian banks to sectors and regions that are extremely vulnerable to nature-related risks. It finds that 54% of the commercial loan portfolios analysed are exposed to sectors highly dependent on ecosystem services, while 87% are exposed to sectors that strongly and negatively impact these services.

Expanding on the work of other central banks and the Network for Greening the Financial System, the exploratory exercise used a set of adverse scenarios relevant to Malaysia and which were mapped to bank’s loan exposures. It examined the direct exposure of banks to physical nature-related risks associated with dependence on ecosystem services, as well as the transition risks associated with negative environmental effects. The study also looked at exposures to key biodiversity areas that may become protected in the future.

The analysis was based on the Encore tool developed by the Natural Capital Finance Alliance, supplemented by interviews with stakeholders. It identified 28 possible nature-related financial scenarios, including 21 focusing on physical risk and seven on transition risk.

The study found that the high exposure of Malaysian banks to physical nature-related risk largely stems from deterioration in surface water, expanding climate-related regulation, and from increased flood and storm incidence and intensity. The negative effects on ecosystems from bank lending were particularly related to greenhouse gas emissions and water use, as well as from the direct use of ecosystem services. In line with similar studies, the analysis found wide differences between individual banks and bank types in both their exposure to physical risk and their effects on ecosystems.

Agriculture, forestry, fisheries and tourism were found to be the sectors most affected in most of the scenarios used. However data limitations mean that exposures may be higher, the report warns. For example, real estate, construction, wholesale and other large sectors are heavily represented in the loan books of Malaysian banks and are vulnerable to limited water availability and deforestation. However these sectors are not well represented in the available scenarios.

The study identifies key areas for improvement in order to manage nature-related financial risks, including raising awareness, building capacity among relevant stakeholders, expanding macroeconomic surveillance capacity and risk identification, and developing regulatory and supervisory requirements. Specific actions that the BNM could take to mitigate nature-related financial risks include further development of methodologies and analyses, linking nature-related risks to ongoing climate change initiatives, and incorporating evolving practices and standards from global financial regulators and supervisors.