Biodiversity Loss and Climate Change: An Unseen Threat to Finance and Banking

Introduction: When Nature sends an invoice?

Consider the 2018 Kerala floods in India, which devastated the state's agriculture, infrastructure, and economy. The floods destroyed over 57,000 hectares of crops, affecting major industries like rubber, spices, and coffee, which contribute significantly to Kerala's economy. Financial institutions, especially those with a substantial portfolio in agribusiness loans, faced heightened credit risks as farmers struggled to repay loans due to crop losses. Insurance claims surged as local businesses and property owners sought compensation for damages.

This catastrophe highlighted the interplay between biodiversity loss, climate change, and financial vulnerability. Deforestation and unregulated land use in Kerala’s ecologically sensitive Western Ghats - a UNESCO World Heritage site - worsened the flood impact. The incident underscored the urgency for banks, insurers, and policymakers to incorporate environmental sustainability and resilience into financial planning to safeguard against nature’s “invoices.”

Picture this too: A major flood disrupts agricultural output, coffee plantations are destroyed by unseasonal rains, and coral reefs - vital to tourism economies - vanish. This isn’t just an environmental crisis; it’s an economic one. Banks financing agribusinesses and tourism suddenly find their portfolios at risk. Insurance companies scramble to compensate damages. As biodiversity loss and climate change accelerate, the financial world must ask: What happens when nature's value collapses??

For long, finance professionals believed that these were distant problems. But with extreme weather events and ecosystem collapses becoming more frequent, it’s becoming clear- this isn’t just an issue for ecologists; it’s a business imperative. Let’s explore how biodiversity loss and climate change intertwine, threatening not just ecosystems but also financial stability and banking operations.?

How biodiversity loss and climate change is a ticking time bomb

Biodiversity loss - caused by deforestation, pollution, and habitat destruction-works hand in hand with climate change. When ecosystems crumble, industries dependent on natural resources, from agriculture to pharmaceuticals, suffer. Financial institutions invested in these sectors take a hit. A failing ecosystem means failed business models, threatening banks' lending portfolios.?

For instance, think of palm oil plantations in Southeast Asia. Fires used to clear land not only destroy habitats but also release massive carbon emissions. This depletes biodiversity while fuelling climate change. Banks funding these activities end up trapped in a vicious cycle—supporting ventures that simultaneously degrade the environment and increase operational risks.?

The Domino Effect: Risk across banking and insurance?

1. Credit Risks: When biodiversity loss depletes natural resources or disrupts ecosystems, borrowers in agriculture, fisheries, or tourism struggle to repay loans.?

?Example: Consider the coffee industry. In recent years, climate change has reduced the viable land area for coffee plantations. Banks financing these plantations now face increased risks of defaults.

2. Market Risks: Investors who put their money in industries tied to nature- such as eco-tourism or sustainable forestry—may experience sudden asset devaluation as ecosystems degrade or climate patterns shift unpredictably.?

?Example: Coral bleaching has already reduced the tourism value of the Great Barrier Reef, impacting tourism operators and, by extension, banks supporting them.?

3. Insurance Risks: Insurers providing coverage for businesses in high-risk areas like coastal zones now grapple with claims from unpredictable disasters like floods and storms, further driven by climate change.?

Example: Munich Re, one of the world’s largest reinsurance companies, has reported increasing losses from weather-related events every year, driven by the twin crises of climate change and biodiversity loss.?

Why finance can’t ignore nature’s bill: Regulatory and market pressures?

Governments and regulators are stepping up their game. The EU has launched initiatives like the Task Force on Nature-Related Financial Disclosures (TNFD), mandating companies and banks to assess their exposure to biodiversity risks. Globally, financial institutions are being pushed to incorporate climate and biodiversity risks into their credit-risk frameworks.?

Take BNP Paribas, a major global bank, as an example. It recently decided to stop financing deforestation-related activities. This shift wasn’t just about environmental responsibility—it was about financial survival. Regulators are watching closely, and markets are quick to punish institutions seen as complicit in environmental degradation.?

Banks Must Adapt or Be Left Behind?

A New Model for Risk Assessment?

In this new world, conventional risk assessments no longer suffice. Financial institutions need frameworks that integrate biodiversity risks with climate risks. This could involve:?

Scenario Analysis: Forecasting how climate events or biodiversity loss will impact business sectors.?

Green Lending: Prioritising loans for sustainable projects that protect or restore ecosystems.?

Biodiversity Stress Tests: Assessing how a bank’s portfolio will perform under various biodiversity - loss scenarios.?

A compelling example is Dutch bank ASN, which has set a goal to make its investment portfolio fully biodiversity-positive by 2030. This means ASN will invest only in companies that protect and restore ecosystems—a bold but necessary move.?

Shifting the paradigm: Sustainability as an opportunity, not just a threat?

While the risks are substantial, opportunities also abound. Banks that embrace sustainability can unlock new avenues for growth. Impact investing, green bonds, and carbon-credit financing offer new business lines. There’s also growing demand for climate-resilient infrastructure, providing banks with avenues to finance green projects.?

Consider HSBC’s decision to launch a $1 billion green bond to support climate-related projects. The returns weren’t just financial—the bank also enhanced its reputation as a sustainability leader.?

Conclusion: Preparing for the new normal?

The convergence of biodiversity loss and climate change is reshaping the financial landscape. Banks and financial institutions must rethink their strategies and actively address these risks. The old business-as-usual approach is no longer viable. Instead, sustainability must become embedded in every loan, investment, and policy decision. It is only by integrating biodiversity risks into financial frameworks, such as scenario analysis and green lending, can Indian financial institutions mitigate the economic impacts of such environmental crises in the future.

Nature is sending a clear message: Ignore these issues at your peril. It’s no longer a question of if biodiversity loss and climate change will impact finance, but when. The question now is—will the financial sector be prepared to adapt in time??