OECD Supervisory Framework for Assessing Nature Related Financial Risks

The OECD launched a methodological supervisory framework to help central banks assess how nature loss affects the financial system. The paper outlines the primary physical and transition risks associated with nature loss, as well as possible channels through which risks may transmit to the real economy and financial system.

According to the authors, there is increasing awareness of biodiversity loss as a material economic and financial risk. The paper integrates ongoing work – by the Network for Greening the Financial System and the Taskforce on Nature-related Financial Disclosures – on nature risk into a methodological framework for central bankers.

Healthy and biologically diverse natural systems are critical to the economy as they provide vital ecosystem services, including food and clean water, flood protection, nutrient cycling and pollination. Yet nature is deteriorating at an unprecedented rate which compromises ecosystem services and subsequently threatens economic and financial stability.

Nature loss, and the actions taken to mitigate it, can have systemic economic and financial consequences as financial institutions hold assets that substantially depend on or harm ecosystem services. 

For instance, the loss of pollination can lead to a decline in crop yields, increasing prices in the value chain, which can pass through economic and financial systems. 

The report offers technical guidance for central banks to identify, prioritise, and assess nature risks through a four-step approach:

1. Risk identification and prioritisation – conduct impact and dependency assessments and identify exposed sectors and ecosystems. When prioritising, authorities should consider the sources, magnitude, geographic location, and time horizons of risks.
2. Economic risk assessments – capture direct and indirect macro and micro-economic risks. Microeconomic risks include loss of earnings, higher operational costs, loss of physical capital, and supply chain disruption. Macroeconomic risks could include changes in trade flows and inflationary pressures. Assessments should consider risk origination, materialisation and propagation between economic sectors.
3. Financial risk assessments – explore how economic risks are transmitted to the financial system through micro- and macro-financial risk channels. The paper focuses on credit, market, and liquidity risks as these are the most understood in the context of nature loss. Authorities should pay special attention to interactions between the real economy and financial markets which may amplify and propagate risks across borders.
4. Considerations for supervisors – establish common definitions and metrics, create international reporting requirements and explore cross-border risks. Once such standards develop, authorities may develop supervisory expectations on financial institutions’ governance, processes, and controls on relevant data, to allow for the expansion of forward looking scenarios for macroprudential assessment of risks.

Finally, the authors say further research is needed to quantify the relationship between biodiversity and price stability, and to understand how nature loss interacts with other types of risks such as underwriting, exchange rate, operational and systemic tail risks.

The methodological framework was developed by the OECD team including Riccardo Boffo, Hugh Miller, Giulio Mazzone and Géraldine Ang in partnership with the Magyar Nemzeti Bank and the European Commission directorate general for structural reform support.