Large European banks’ dependency on – and exposure to – ecosystem services shows that considerable value is at risk

Banks play a significant role in our society and have a pivotal role in fostering sustainable development. Assessing, understanding and disclosing banks’ dependencies on ES can help to better align the functioning of our economies with the quality and quantity of ES available, and define healthy levels of ecosystem services to ensure financial resilience and stability.

Researchers assessed the monetary value of the ES dependencies of the 10 largest European banks by equity portfolio, after highlighting both a scarcity of studies in this area and the fact that banks have been slow to integrate and evaluate their dependencies on ES. 

Banks may invest in economic activities that rely on healthy ecosystems such as fishing or agriculture, or on projects that are working on the protection or restoration of ES such as nature conservation. Banks may also invest in economic activities that harm the quality and quantity of ES. This study suggests that environmental risks associated with these projects (for example deforestation or pollution) may subsequently translate into financial risks for the banks. 

Therefore, banks that invest in projects that are potentially affected by ES dependencies and related risks are more exposed to a higher likelihood of defaults, decreased asset value, and increased nature-associated value at risk – a metric used to measure the potential losses that a bank may incur due to adverse changes in ES.

The researchers replicated a methodology used in a study on De Nederlandsche Bank, applying it to the 10 largest European commercial and investment banks using data from the end of 2020. They focused solely on equity holding portfolios and used information on ES dependencies from the ENCORE web-based tool, developed by Natural Capital Finance Alliance. This is based on the global industry classification standard and provides information on how business production processes are dependent on ES. The researchers translated these into sub-industry ratings by calculating the average and maximum ‘ES dependency rating’ for each business process. Investments were classed as ‘highly dependent’ if they fell within the top 33% of the ES-dependency rating.

Their analysis estimates that, for every dollar of equity held, 26 cents are highly dependent on ES, amounting to approximately $US 335 billion (317 billion euros), or 26.8% of the equity held. Considering the small sample of banks and the limited scope of the assessment (i.e. equity holdings), the researchers state that this figure should be regarded as a lower, conservative estimate. 

The banks most dependent on ecosystem services, in absolute terms, are: UBS Group AG ($US 87 billion, 82 billion euros) and the Deutsche Bank AG ( $US 69 billion, 65 billion euros). However, when looking at relative value at risk – when equity exposed to ES is compared with equity not exposed to ES, in an individual bank – Société Générale was most dependent (33.7%, $US 20 billion, 19 billion euros) over $US 60 billion (57 billion euro), and Barclays showed the least relative value at risk (21%; $US 8.6 billion, 8 billion euros) over $US 41 billion (39 billion euros). 

The highest bank dependencies were on ecosystem services that provide mass stabilisation (stabilising effects of vegetation that minimise soil movement and landslides) and erosion control ($US 40 billion, 38 billion euros), surface water ($US 34 billion, 32 billion euros), groundwater ($US 34 billion, 32 billion euros) and flood and storm protection ($US 33 billion , 31 billion euros). 

The researchers note that the sampled equity portfolios have a high dependency on water-related ES, and this, along with soil erosion risks, could provide an area of concern for equity portfolio managers. The research also identifies specific industries that act as important ‘transmission channels’ between the ecosystem services-related risks and financial risks for banks. For example, electrical utilities rely on ground and surface water, water-flow maintenance and water quality, bioremediation and filtration, and climate regulation and mass stabilisation. Note that the ES dependencies hinge on specific geographical location of supply chains and businesses/assets, and secondary production dependencies (for example, on food products) were not accounted for in this study. 

The researchers state that the understanding of banks’ dependencies on and exposure to ES remains limited. While awareness among banks and regulators is growing, challenges remain, especially with limited data and tools to assess, manage and disclose ES dependencies. They recommend that policymakers, banks and their supervisory authorities should develop a clear definition of ES risks and dependency factors and banks should develop and disclose ES risk-management strategies, supported by guidance from supervisory authorities, clear assessment frameworks and national regulations.

Banks need to accelerate their production of robust and credible data on ES dependencies, say the researchers. This could be supported via the EU’s Corporate Sustainability Reporting Directive, which can require companies to supply banks with reliable data, which could in turn increase the credibility of the banks’ ES dependency data. The researchers also suggest that banks need to develop new stress-test methodologies and scenarios to measure their dependencies more accurately. One example they give is to overlay maps of a company’s supply chains or activity with maps of sensitive ES. Central banks could also set an example, by making public their own ES-dependency assessments. 

The researchers suggest that banks need to pursue greater understanding of their dependencies on ecosystem services, becoming ecosystem services ‘champions’ to ensure their own financial sustainability and longer-term resilience.

Reference: 

Mundaca, L. and Heintze, J-N (2024). Banking on ecosystem services. Ecological Economics 224 (October 2024): 108284. https://doi.org/10.1016/j.ecolecon.2024.108284

To cite this article/service:

“Science for Environment Policy”: European Commission DG Environment News Alert Service, edited by SCU, The University of the West of England, Bristol.

Notes on content:

The contents and views included in Science for Environment Policy are based on independent, peer reviewed research and do not necessarily reflect the position of the European Commission. Please note that this article is a summary of only one study. Other studies may come to other conclusions.