Central banks and financial regulators can’t ignore nature: Lessons from South Africa

The agricultural lending portfolios of South Africa’s largest banks face significant financial risks from nature degradation, which exacerbates the risk and impact of fire, flooding and drought across the nation – this is the finding of a new report from Global Canopy. The report offers insights relevant to banking systems globally, and carries an important takeaway for central banks and financial regulators throughout the world.

By Dr Natacha Postel-Vinay

Technical Nature-Related Finance Lead, Global Canopy

Nature dependence among South Africa’s agricultural businesses and commercial banks

Global Canopy has released a new report, ‘Accounting for Nature: An assessment of nature-related risk and prudential policy in the South African banking sector’, which provides insights into the ways in which some of the nation’s largest commercial banks’ lending portfolios depend on nature.

Using the free online tool ENCORE, we assessed the agricultural, forestry and fishing loan books of South Africa’s biggest banks to determine their exposure to physical, nature-related risks through their lending to business clients in these sectors. We found that most of these banks have a ‘very high’ dependence (according to ENCORE materiality classification) on multiple ecosystem services (the direct and indirect contributions ecosystems provide for human wellbeing and quality of life) through these portfolios. The banks’ clients raise livestock, grow fruit, produce crops, and undertake commercial forestry and logging activities. This means their businesses depend on a host of ecosystem services such as pollination, surface and groundwater-related services, climate-regulating services – which limit the risk of wildfires, flooding and landslides – and soil quality.

South Africa’s agricultural businesses depend on nature in myriad ways to keep afloat

In short, South Africa’s agricultural businesses depend on nature in myriad ways to keep afloat, and consequently, the country’s banks have dependencies on nature given their financial interest in their clients’ success. If these ecosystem services falter, it will no doubt have a negative impact on the bottom line of those businesses – fewer crops, fruit and livestock to sell and a fall in profits, for example – which creates financial risk for the banks that have granted them loans.

The report underscores the fact that investment in nature is an investment in business. It’s clear that both South Africa’s agricultural businesses and its largest banks would benefit significantly from the restoration of native forests and hedgerows next to fields, given the key role of native vegetation in regulating water quantity and quality, soil quality and climate conditions.

Implications for the financial services sector – in South Africa and beyond

The fundamental principle that agricultural business activities – and the banks that finance them – depend on nature to succeed is not unique to South Africa. It’s universal, and a key takeaway from the report is that central banks and regulators in every country would do well to understand the extent to which their nation’s banking system depends on nature. 

ENCORE offers a good starting-point to gain this understanding. It was used in the research underpinning this report, and it can support a wide range of organisations – from businesses to financial institutions, to central banks and regulators – to explore sector-level exposure to nature-related risk and take the first steps to understand dependencies and impacts on nature.

Central banks and regulators can use ENCORE to build an understanding of their country’s commercial banks’ lending and investment portfolios’ exposure to physical, nature-related risks at sector level. Although agriculture was the focus of this report, many other sectors, such as insurance, real estate and energy, are highly dependent on nature’s regulating services, and ENCORE can help shed light on those as well. 

Informed by the fundamental nature dependence insights gained through ENCORE, they can consider taking action to reduce this commercial banking dependence on nature in the interest of maintaining financial stability in their country.

If they did go down that route, they could take supervisory measures, such as requiring financial institutions to undertake more indepth assessments to better understand their dependencies on nature and the consequences of this for those institutions, and their country’s economy. Further, they could decide whether new regulations ought to be introduced to strengthen the economy. 

First and foremost, they could target the root cause of the problem and encourage government authorities to better regulate the disclosures and due diligence efforts of the companies that financial institutions invest in. 

Every country’s banks depend on nature. Unless they take steps to understand the extent of this dependence, they will be oblivious to important financial risks, with potential knock-on effects on the wider economy. Central banks, financial regulators, and commercial banks worldwide can take the first step today by using ENCORE to get a broad sector-based perspective of this dependence.

The report, ‘Accounting for Nature: An assessment of nature-related risk and prudential policy in the South African banking sector’, was developed with financial support from the Swiss State Secretariat for Economic Affairs, SECO, under the ‘From Awareness to Action: ENCORE Phase II’ project.

ENCORE is a free, online tool that helps organisations explore their exposure to nature-related risk and take the first steps to understand their dependencies and impacts on nature.