How natural capital decline affects the financial system and the tools, strategies and regulatory changes helping banks respond.
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How natural capital decline affects the financial system and the tools, strategies and regulatory changes helping banks respond.
How natural capital decline affects the financial system and the tools, strategies and regulatory changes helping banks respond.
The degradation of the natural environment, now increasingly intensified by climate change, presents mounting financial risks for the global economy. Market estimates suggest these nature-related risks could lead to economic losses in the trillions of dollars, with one prominent study placing the figure as high as $5 trillion (Oxford 2023). The banking sector stands particularly exposed, primarily due to its lending to industries that rely heavily on ecosystem services.
This article outlines why nature degradation is now a systemic financial risk, and what this means for banks and financial supervisors. It explores how nature-related risks are transmitted into the financial system, the tools and frameworks emerging to measure and manage this exposure, and how regulators are beginning to respond.
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Nature degradation — defined as the deterioration of ecosystems, biodiversity, and the quality of natural resources — is closely intertwined with climate change. Together, these environmental crises pose a dual threat to the foundations of economic activity. As vital ecosystem services like clean water, fertile soil, climate regulation, and pollination deteriorate, so too does the stability of the financial systems that rely on them (Grantham Research Institute 2023).
This shift in understanding has sparked growing concern within financial and regulatory institutions. The idea of “natural capital” — the stock of natural assets that provide critical economic benefits — is now entering the mainstream of financial thinking (Green Central Banking 2023). As this recognition deepens, financial institutions are beginning to assess how their exposures align with natural systems and to adapt risk management and governance accordingly.
Recent estimates make one thing clear: the financial consequences of nature degradation are no longer speculative — they are quantifiable, material, and rapidly escalating. A 2023 study from Oxford University places the global economic impact of nature-related risks at up to $5 trillion, underscoring how the loss of critical ecosystem services, such as water regulation, pollution absorption, and pollination, could amplify climate impacts and trigger cascading disruptions across sectors (Oxford 2023). These include heightened risks of pandemics, food insecurity, floods, and droughts.
The World Bank adds weight to this outlook, warning that even a partial collapse of ecosystem services could slash global GDP by $2.7 trillion per year by 2030 (World Bank 2021). Industries like agriculture, forestry, and fisheries — all heavily reliant on nature — are particularly exposed, and the financial consequences extend far beyond environmental or sectoral concerns. For central banks and financial supervisors, these risks are now recognised as central to macroeconomic and financial system stability (FSB 2023).
The UK offers a pointed example. According to the Green Finance Institute, nature degradation could lead to a 12% loss in national GDP, with nearly half of this risk originating overseas, linked to international supply chains and cross-border lending (Green Finance Institute 2024). This finding not only highlights the financial scale of nature-related risks but also underscores their global interconnectivity: no country, however developed, is insulated.
These national and international projections reflect a growing consensus. Nature-related financial risks are systemic, growing, and urgent — and understanding how they translate into financial exposure is fast becoming a strategic imperative for banks, investors, and regulators alike.
The UK’s financial system is deeply interwoven with natural capital, both at home and abroad. As detailed in the Green Finance Institute’s report Assessing the Materiality of Nature-Related Financial Risks for the UK, the nation could face a GDP reduction of 12% if ecosystem degradation continues unabated (Green Finance Institute 2024). This impact would outstrip the shocks of the 2008 financial crisis and the COVID-19 pandemic.
For UK banks, this systemic risk is mirrored in lending portfolios. The report suggests some institutions could see portfolio value reductions of 4–5%, with agriculture, manufacturing, and utilities flagged as particularly vulnerable (Green Finance Institute 2024). These sectors depend on core ecosystem services — fertile soil, pollination, clean water, and climate regulation — many of which are under mounting strain.
Importantly, the UK’s exposure is not confined to domestic ecosystems. Roughly half of its nature-related financial risks are imported, carried through global supply chains and international investments (Green Finance Institute 2024). As a global financial centre, the UK is inherently exposed to cross-border ecological shocks.
Regulators are taking notice. The Bank of England, using the ENCORE tool, has identified that over half of UK GDP and nearly three-quarters of bank lending rely on nature (Bank of England 2022). In collaboration with DEFRA and other partners, the Bank is actively integrating nature risks into supervisory frameworks, risk modelling, and scenario analysis, recognising nature as a core input in economic and financial planning.
The eurozone faces a similarly entrenched risk landscape. According to ECB analysis, approximately 75% of all bank loans in the region go to companies highly dependent on at least one ecosystem service (ECB 2023). That degree of exposure indicates that nature degradation could present a systemic threat to financial institutions across the EU.
Research by De Nederlandsche Bank and Banque de France reinforces this view, showing that biodiversity loss poses tangible risks to banks’ credit, market, and operational positions (WEF 2023). These institutions are increasingly recognising that nature-related risks are not an emerging subset of ESG concerns — they are integral to traditional financial risk management.
For the ECB, the degradation of natural capital is now seen as a driver of core risk categories: credit risk (from loan defaults), market risk (from devalued or stranded assets), and operational risk (from supply chain disruption, infrastructure damage, or reputational harm) (ECB 2024). Its supervisory frameworks now reflect this understanding, signalling a shift in how nature is incorporated into macroprudential oversight.
Like climate-related risks, nature-related financial risks are typically grouped into two categories: physical risks and transition risks. Both present significant implications for economic activity and financial stability, and both are now being scrutinised by regulators, central banks, and financial institutions.
Physical risks arise directly from the degradation of natural ecosystems. These risks manifest when the loss of biodiversity or the depletion of ecosystem services, such as clean water, fertile soil, climate regulation, or pollination, begins to impact real-world assets and business operations.
One of the most immediate physical risks is the increasing frequency and intensity of extreme weather events — floods, droughts, storms — that can damage infrastructure, disrupt supply chains, and destabilise regional economies. These climate-amplified events often coincide with nature degradation, compounding their effects. For example, the deforestation of catchment areas exacerbates flood risks, while soil erosion worsens the impacts of drought (CISL 2022).
Beyond weather events, resource scarcity is emerging as a significant concern. Shortages of water, declining soil fertility, and the loss of essential pollinators all have clear implications for sectors such as agriculture and manufacturing (ECB 2024). In agriculture, for instance, reduced crop yields linked to pollinator decline can affect food security and lead to increased loan defaults among farming clients. Similarly, manufacturers dependent on specific natural inputs may see operational costs and supply chain risks rise.
For financial institutions, these physical risks can translate into credit losses, as affected borrowers are more likely to default, and into asset devaluation, particularly where physical assets are located in high-risk or ecologically fragile zones. The interconnected nature of climate and nature risks means these impacts are likely to be non-linear and mutually reinforcing — climate change accelerates ecosystem collapse, and nature degradation heightens climate vulnerability (ECB 2023).
Transition risks arise from the shift to a nature-positive economy. These include the regulatory, technological, and societal changes required to halt biodiversity loss and protect natural systems.
Regulatory change is one of the most visible drivers of transition risk. Governments and multilateral bodies are implementing new laws and standards aimed at sustainable land use, conservation, and nature-related disclosures (FSB 2023).
Technological change presents another layer of risk. Innovations in sustainable agriculture, circular economy models, and ecosystem restoration are disrupting traditional business models. Firms unable to adapt could find themselves sidelined as investors and customers pivot toward lower-impact alternatives (WEF 2024).
Shifting consumer and investor expectations also play a growing role. There is rising demand for transparency, traceability, and environmental responsibility across supply chains. Financial institutions that continue to back unsustainable practices may face reputational damage, divestment, or stakeholder pressure.
Finally, legal exposure is an emerging frontier in transition risk. As awareness of nature-related harm grows, courts are increasingly willing to entertain litigation against companies and financial institutions deemed responsible for environmental damage (ECB 2024). This evolving legal landscape introduces uncertainty and potential liability, particularly in jurisdictions advancing environmental due diligence laws.
One complicating factor in managing transition risks is the lack of a universally agreed-upon target akin to the “net zero” goal for climate change. The emerging concept of being “nature positive” is gaining traction, but remains less precisely defined, making it harder to assess and compare progress across industries and regions (OMFIF 2025).
Together, physical and transition risks underscore the systemic nature of nature degradation. They are reshaping how risk is defined, measured, and managed, necessitating deeper integration of environmental intelligence into financial decision-making.
Banks are increasingly exposed to nature-related financial risks through a web of interconnected channels that can directly affect their profitability, capital adequacy, and operational continuity. These risks stem not only from the physical degradation of ecosystems but also from the transitionary pressures of moving toward more sustainable economies.
A primary channel of exposure is credit risk—the possibility that borrowers may default on their obligations due to the effects of nature degradation. This is especially acute in sectors heavily reliant on ecosystem services, such as agriculture, forestry, fisheries, and tourism.
The European Central Bank (ECB) reports that nearly 75% of all loans within the euro area are extended to companies with a high dependence on at least one ecosystem service (Green Central Banking 2023). This statistic highlights the vulnerability of loan portfolios if ecosystem decline continues unchecked.
For instance, farmers facing drought, pollinator loss, or soil degradation may see reduced crop yields, impairing their ability to service debt. Similarly, tourism-dependent businesses may suffer from degraded natural attractions or extreme weather events, undermining revenues and raising default risk.
To address this, some banks are starting to integrate "nature exposure scores" into their credit risk models — tools analogous to carbon exposure metrics that allow for a more nuanced assessment of borrower vulnerability in nature-dependent sectors (CEPR 2024).
Banks also encounter nature-related risk through their asset holdings. Investments in companies with environmentally harmful practices, or in assets physically located in regions vulnerable to ecosystem loss (e.g., coastal or drought-prone zones), are subject to devaluation as awareness of nature risk increases.
As economies shift toward sustainability, brown assets — those tied to unsustainable or extractive industries — are likely to lose value. Investor sentiment, regulatory shifts, and emerging disclosure frameworks like the TNFD are already redirecting capital toward nature-positive enterprises, further elevating the risk for banks holding lagging assets (TNFD 2025).
Nature degradation introduces new dimensions of operational risk for banks. Intensifying extreme weather events, such as floods or hurricanes, can damage physical infrastructure, including branches, ATMs, and data centres, causing costly business interruptions.
More subtly, banks may face legal and reputational risks if they are seen as enablers of ecosystem destruction. The rise in nature-related litigation against financial institutions, along with growing consumer awareness, underscores the operational importance of environmental responsibility (ECB 2024). Negative headlines and public scrutiny can erode customer trust and brand equity, risks that increasingly show up on banks’ operational risk registers.
Although more indirect, liquidity risk can also arise from environmental instability. Major ecosystem shocks, such as widespread agricultural collapse or water scarcity, could trigger economic slowdowns, impacting borrower solvency and tightening credit conditions.
In such scenarios, banks may find it more difficult to raise capital or secure short-term funding. If multiple sectors simultaneously experience nature-induced stress, the resulting financial contagion could have cascading effects on liquidity markets, particularly in regions with limited fiscal resilience or under-diversified economies (FSB 2023).
The impact of nature degradation varies significantly across economic sectors, leading to differing levels of financial risk exposure for banks and other lenders. These variations highlight the need for sector-specific analysis when assessing nature-related financial vulnerabilities.
The agricultural sector is acutely dependent on ecosystem services such as pollination, healthy soils, and stable water supplies. Degradation in any of these areas can severely affect crop yields and livestock productivity, resulting in reduced revenues for producers and an increased likelihood of loan defaults. This has direct implications for financial institutions with significant agricultural lending portfolios.
Emerging studies suggest that lenders are beginning to price this risk into their decisions, charging a premium on loans to firms with high exposure to nature-related vulnerabilities (CEPR 2024). Soil degradation, in particular, has been shown to amplify financial vulnerability along the agricultural value chain, underscoring the need for lenders and investors to integrate soil health metrics into their environmental risk assessments (CISL 2022).
The utilities sector is another area with high exposure to nature-related risks. Many power generation systems — particularly thermal and nuclear plants — rely on natural water bodies for cooling. Water scarcity, pollution, or altered river flow patterns caused by environmental degradation can disrupt operations, increase costs, and reduce the reliability of supply.
Such disruptions pose operational and financial risks not only for utility providers but also for the banks that finance them. Prolonged or repeated resource constraints may translate into higher energy prices, reduced cash flows, and elevated credit risk.
Real estate markets are increasingly vulnerable to both acute and chronic impacts of environmental degradation. Properties located in regions prone to flooding, wildfires, or sea-level rise may face devaluation, elevated insurance premiums, or — in some cases — become uninsurable. This raises the risk of mortgage defaults and asset impairment across financial institutions with significant real estate exposure.
The concept of “stranded assets” is becoming more relevant in real estate finance, where once-profitable holdings may become liabilities due to changing environmental conditions. Interestingly, new research suggests that the energy efficiency of properties may serve as a proxy for broader environmental risk, with correlations identified between poor energy performance and increased default rates (UNEP FI 2024).
Nature-related risks extend to a wide range of other industries. The manufacturing sector, for instance, depends heavily on raw materials whose availability and cost are tied to healthy ecosystems. Tourism relies on the integrity of landscapes, biodiversity, and climate stability — assets that are rapidly eroding. Fisheries, too, are directly impacted by the health of ocean ecosystems, which are facing growing threats from pollution, acidification, and overexploitation.
In each of these cases, degradation of natural capital can reduce profitability, disrupt operations, and increase financing risk, presenting significant challenges for the banks and investors supporting these sectors.
Quantifying nature-related financial risks presents unique challenges when compared to climate-related risks. Biodiversity is multi-dimensional, context-specific, and often difficult to represent in standardised metrics. Compounding this complexity is the relative scarcity of robust data, which makes it hard to apply global scenarios uniformly across financial institutions and geographies (OMFIF 2025).
Despite these hurdles, a number of promising tools and frameworks are emerging to help banks and financial regulators identify, assess, and manage their exposure:
Exposure analysis: This methodology helps financial institutions evaluate their direct and indirect exposure to ecosystem services and nature-dependent sectors. Tools like ENCORE (Exploring Natural Capital Opportunities, Risks and Exposure) support banks in identifying potential sources of physical and transition risks within their lending and investment portfolios (Bank of England 2022).
Scenario analysis: To understand how nature degradation might evolve and interact with policy changes, financial institutions are developing forward-looking scenarios. These often rely on biophysical models, economic impact forecasting, and nature-economy simulations to explore different risk pathways and outcomes (NGFS 2024).
Stress testing: Some regulators and institutions have begun incorporating nature-related shocks into their stress-testing frameworks. These exercises aim to test the resilience of financial systems to sudden ecosystem service losses or disorderly transitions to nature-positive economies (FSB 2023).
Taskforce on Nature-related Financial Disclosures (TNFD): The TNFD has introduced a comprehensive framework to help organisations disclose how nature impacts their operations and how they, in turn, affect nature. This encourages consistency and transparency, enabling comparability across institutions and markets (TNFD 2023).
Nature Risk Profile (UNEP & S&P): This initiative provides financial institutions with quantifiable methodologies to assess company-level nature impacts and dependencies. It aims to support more informed lending and investment decisions (UNEP 2024).
Ecosystem Dependence Score Indicator (EDSI): Proposed by the Dutch central bank, the EDSI offers a quantitative method to estimate potential financial losses linked to disruptions in ecosystem services, adding precision to credit risk modelling (Green Central Banking 2024).
LEAP Approach (TNFD): Standing for Locate, Evaluate, Assess, Prepare, this practical guidance supports organisations in identifying and responding to nature-related risks. The LEAP method complements the TNFD disclosure framework and provides a repeatable due diligence pathway (TNFD 2023).
The steady growth and refinement of these tools reflect a maturing understanding of nature-related financial risks. Importantly, they mark a shift away from general exposure analysis toward integrated risk frameworks that can support action-oriented decision-making at the boardroom level.
As the financial implications of environmental degradation become more apparent, central banks and financial supervisors are moving rapidly to integrate nature-related risks into their oversight frameworks. These institutions now recognise that nature loss, like climate change, is not just an environmental concern, but a source of systemic financial instability.
The Network for Greening the Financial System (NGFS) has taken a leading role in this domain. Its conceptual frameworks offer central banks and supervisors structured approaches for understanding how nature impacts traditional risk categories, from credit to liquidity (NGFS 2024).
In the Eurozone, the European Central Bank (ECB) has already begun embedding nature considerations into its supervisory agenda. Rather than treat nature-related risks as standalone, the ECB sees them as cross-cutting drivers of existing financial risk types. This reflects a growing recognition that biodiversity loss and ecosystem collapse have material consequences for banks’ capital adequacy and lending portfolios (ECB 2024).
The Bank of England is also taking an increasingly active role. It is collaborating with government agencies, including DEFRA, to evaluate how ecosystem service degradation could affect the UK economy and its financial institutions. Initiatives include incorporating nature data into macroeconomic models and conducting joint assessments of financial exposures (Bank of England 2022).
At the international level, the Financial Stability Board (FSB) has conducted a stocktake of regulatory and supervisory responses to nature-related risks. This mapping exercise highlights global momentum, with many jurisdictions either piloting frameworks or signalling regulatory interest in the topic (FSB 2023).
Similarly, the OECD has proposed supervisory guidelines to help financial authorities assess and manage biodiversity-linked financial risks. These include early-stage policy templates and precautionary measures to bridge gaps where data is insufficient (OECD 2023).
A common theme across these efforts is the call for a precautionary approach. Given the complexity, uncertainty, and potential irreversibility of ecosystem collapse, many regulators advocate acting before all data is in place, recognising that waiting for perfect information may come too late to avoid material impacts (FSB 2023).
Together, these evolving frameworks and policies suggest a phase of rapid learning and capability-building among regulators. The long-term implication is clear: nature-related financial risks will likely become a permanent feature of supervisory discussions, stress testing exercises, and potentially even capital requirements.
Banks and financial institutions that proactively integrate nature risk into their governance, strategy, and operations are not just managing downside; they are building resilience. As regulations evolve, markets adapt, and public scrutiny intensifies, transparency around nature impact and dependence will become a competitive differentiator.
Just as climate risk moved from fringe concern to boardroom priority, nature-related risk is following the same trajectory — only faster.
Dr. Genevieve Patenaude is CEO and co-founder of Earth Blox. Previously, an associate professor at the School of Geosciences, University of Edinburgh, Genevieve led multiple international research projects on the exploitation of Earth Observation and big data to solve global challenges. She contributed to the Good Practice Guidance for Land Use, Land-Use Change and Forestry for the Intergovernmental Panel on Climate Change, and has published in Nature.
