Banking on nature: How banks can navigate the next frontier of sustainability

Investing in and protecting the natural environment can significantly bolster GDP by enhancing ecosystem services, promoting sustainable agriculture, improving public health, mitigating climate change, and boosting tourism. Healthy ecosystems provide essential services such as clean air and water, pollination, and climate regulation, which are fundamental to various economic activities. Sustainable agricultural practices reduce costs and ensure long-term productivity, while a healthy environment contributes to better public health, reducing healthcare costs and increasing productivity. Protecting natural habitats also plays a crucial role in carbon sequestration, mitigating climate-related disasters and enhancing economic stability. According to the Natural Capital Committee, World Health Organisation, and the Global Commission on the Economy and Climate, these strategies can deliver significant economic benefits.

For many banks, the sustainability agenda to date has been fairly dominated by climate and greenhouse gas emissions. This represents a comfort zone for banks; it is distinctly empirical. The shift in focus to include nature, signals the movement outside of that comfort zone, bringing both opportunities and challenges.

Nature is split into four realms: land, freshwater, ocean, and the atmosphere, which form key building blocks for business and finance (particularly the corporate, commercial, and investment divisions) to understand their impact on different ecosystems Similar to climate responsibilities, nature represents not only the ‘right thing to do’ for the planet but will also help de-risk portfolios and address rising pressure from regulators, shareholders, and customers.

So how can financial institutions identify some of the challenges and opportunities of nature, and what do tangible steps to capitalise on nature-positive outcomes look like?

Facing into the challenges

The first challenge involves the physical and transition risks. For example, banks with large loan portfolios in sectors like agriculture, fisheries, and forestry face risk from environmental degradation or extreme weather. Transition risks include new regulations introduced to mitigate climate change.

The World Economic Forum estimates that $44 trillion of economic value creation is moderately or highly dependent on nature and its ecosystem services (food, raw materials, climate regulation, air quality regulation, biodiversity, and nutrient recycling). Corporate and institutional banks are likely to be the financial institutions most at risk of financial loss, with 75 percent of corporate loans being exposed to sectors that are highly dependent on at least one ecosystem service. In the UK, analysis of the seven largest UK banks indicates possible near-term adjustments in the values of domestic holdings of up to four to five percent from nature-related risks alone.

The second challenge is the reporting and disclosure requirements against an increasing number of regulations. The good news is those that have put in robust data and reporting foundations for their climate-related disclosures, will have strong foundations already. A lot of the disclosures (such as Corporate Sustainability Reporting Directive – CSRD – coming into force in 2024) build on existing ones like The Taskforce on Nature-related Financial Disclosures - NFRD. This is true for nature, as the Taskforce for Nature-related Financial Disclosures (TNFD – currently voluntary but expected to become mandatory) - follows on from Taskforce on Climate-related Financial Disclosure (TCFD). But for those with relatively immature reporting capabilities, the additional data points relating to biodiversity, water usage, and so on, will likely create more challenges.

Capitalising on the opportunities

The sustainability-related debt market has grown significantly in the past five years - Sustainability Linked Loans have grown at a CAGR of 143 percent between 2017 and 2022 for instance. Despite this significant growth, the Paulson Institute has estimated an annual investment gap in biodiversity of between $598bn and $824bn per year. This represents an opportunity to provide lending to organisations who are seeking to improve their environmental impact and risk management. In the case of just CSRD, an estimated 50,000 companies will be subject to mandatory sustainability reporting in 2024, with additional disclosures specific to nature and biodiversity expected to begin in 2025, so could feasibly require financing to improve their sustainability and nature-related KPIs.

The second opportunity is in the nature credit market. As we have seen with the Voluntary Carbon Market (VCM), as regulatory pressure and disclosures ramp up, so has the demand for offsets. We can expect a similar trajectory for the nature credit market. In the UK, the starting pistol has been fired with the introduction of the biodiversity net gain targets being put upon new housebuilders. The World Economic Forum estimates that demand for voluntary biodiversity credits will be worth $2bn in 2030 growing to $69bn by 2050. For banks, the opportunity lies in financing projects generating the credits – this could be for a large FMCG or for farmers seeking to diverse revenue streams.

Where to start

Identify impacts and dependencies

Using open-source frameworks such as ENCORE are a great place for banks to start to assess their portfolios. Banks should be assessing their portfolios to identify the sectors and clients where there is a significant impact and/or dependency on ecosystem services. Typically, businesses with dependencies or impacts on agricultural, fisheries, forest products, real estate, construction, and power utilities have high dependencies on ecosystem services.

Manage impacts and dependencies

Once those impacts and dependencies are identified, the focus should shift to managing them. This will involve setting targets with clients, tracking against pathways, or in some cases divestment or non-renewal of lending agreements. Again, we expect nature to follow a similar path to climate and emissions. Credible transition plans are already being put in place with corporate banking clients but are currently focused on greenhouse gas emissions. This approach can also be used to take on nature considerations, minimising the impact on clients and internal reporting teams. This also underlines the need to have strong data foundations in place as the disclosure requirements grow.

Identify the opportunities

Based on a given bank’s dependencies and impacts, and conversations with clients on credible transition plans, the opportunities will vary based on sector exposure. This may come in the form of loans to housebuilders to meet their biodiversity net gain commitments, or loans for landowners to create biodiversity credit-generating projects. It may also come in the shape of green/blue bond issuance advisory. Given the maturity of the market, blended finance (mixing private, philanthropic, and public capital) will play a role as the understanding of risk and returns evolve, and we expect winners in this sector to start convening key stakeholders soon.

Like climate challenges, the loss of nature represents both an opportunity and a challenge for all financial institutions but especially banks. Whilst the frameworks, policies, and regulations are nascent, there is a compelling case for banks to get ahead of the curve to capitalise on the opportunities that are abundant in nature.