A Biodiversity Stress Test of the FinancialSystem

This paper provides the first rigorous assessment of the financial sectors’ resilience to biodiversity transition risk. A wide range of indicators point to rapid realized and projected biodiversity loss (IPBES, 2019). Biodiversity richness provides economic value through ecosystem services such as pollination. Biodiversity loss is, therefore, costly. The World Bank (2021) projects real GDP losses of expected biodiversity loss to equal $225 billion globally by 2030. Under stress scenarios assuming the collapse of ecosystem services, projected losses rise to $2.7 trillion. Therefore, financial regulators are concerned that these losses are large enough to cause financial instability.To evaluate this risk, we employ two complementary approaches which allow us to get a very comprehensive picture of the potential losses from biodiversity transition risk: We provide a “bottom-up” stress test using comprehensive euro-area credit registry data (AnaCredit) and a market-based “top-down” stress test based on banks’ stock return sensitivities to biodiversity risk. Our findings reveal that industries exposed to biodiversity transition risk represent roughly 16% of total bank credit to non-financial firms, compared to 27% for those exposed to climate transition risk. Stress test scenarios indicate that even under severe conditions, additional losses in biodiversity-exposed industries would constitute only 0.27 to 0.4% of the financial system’s corporate loan portfolio. A top-down market-based approach yields similar results with capital short-falls following a biodiversity shock peaking at 0.1% of banks’ assets.Overall, our results suggest that the financial stability risks associated with biodiversity transition remain moderate. Both our credit-based and market-based analyses find little evidence that biodiversity or climate transition risks significantly impact Euro Area banks. Importantly, biodiversity-related financial risks are consistently smaller than those from climate transition. Therefore, financial stability considerations should not impede the adoption of robust biodiversity policies. Instead, effective biodiversity conservation should be pursued as an essential component of sustainable economic growth.