 Nature is in danger. Let's look at Europe. 80% of habitats are in bad condition. 10% of bee and butterfly species risk extinction. And 70% of soils are in bad shape. And things are getting worse. We depend on nature. We need it to grow food, build our businesses and our homes. We need it to live. And the economy also needs nature to survive. This brings me to our topic today. How does nature loss impact the economy? And what is our role as a central bank? You're listening to the ECB podcast, bringing you insights into the world of economics and central banking. My name is Stefania Secola. With me today is Frank Elderson, executive board member and vice chair of the supervisory board. Welcome back to the podcast, Frank. Great to have you again. Thank you for having me, Stefania. A pleasure. Frank, you often talk about climate and nature. I imagine as a central banker you have your hands full. We're still fighting inflation and there are other challenges. Are you also now trying to save the planet? Good question. So biodiversity and nature services loss, as we call it, can impact people and business. Just like many other big item changes, like demographics, like globalization, like digitalization. So also biodiversity and nature services loss affect the economy and banks. And it's actually very simple. Yes, ultimately the question is about saving the planet. Or actually more accurately, because the planet as a planet will survive, saving the habitability of the planet. But it is also, and this is of course important for us, about our mandate, about our role, our legal role. And that is about safeguarding price stability. It's about financial stability. It's about a resilient banking system. So if we don't take climate, environment, biodiversity and nature-related aspects into account, we would actually be failing to deliver on our mandate. Yeah. And let's get deeper then and try to understand better how biodiversity and nature loss affects the economy. Can you give us a concrete example? Okay. Let's talk concrete examples. But before doing that, maybe to just say very generally, nature is the foundation of the economy. So if you destroy nature, you destroy the economy. Let me then go a little bit in more detail on two aspects. So I'll come back to the second. But first, most people just think about biodiversity, but actually the subject is much broader, much wider than just biodiversity. A big part of it is what we actually call nature services. So what nature provides us for free. For example, water, clean air, but also things like natural erosion control or carbon storage. So all things that we kind of like take for granted, but we should not. The links between nature service and farming are obvious. Agriculture heavily relies on what nature provides for free, fertile soils, fresh water, for example. And if you look at the soil today, up to 73% of agricultural land suffers from soil degradation here in Europe. Yes. And this can have, you know, many, many reasons. And monoculture cultivation, for example, so only focusing on growing one specific crop or the use of fertilizers. So imagine I'm a farmer and so what I need is fertile soil, fertile soil to grow my weeds and my grains. But the degradation of this nature service, as we call it, will of course clearly impact my business and all of us individually. Because in the end, this, me being able to produce less will in the end, of course, affect food production, food prices, etc. So actually, if I now kind of like, you know, go back in my shoes of a central banker and a banking supervisor, and I leave my farmer example for a second, this is what we would call a physical risk. A farmer or me as a farmer, I need to assess the risk and see what it means for my business. Because if as a farmer I produce less, it might be more difficult for me to pay back the bank. So from the bank's perspective, the credit risk becomes bigger. And of course, as a banking supervisor, that is relevant. Yes. So we have our example. The example is indeed the farmer, right? That suffers all these potential difficulties and in turn the bank might face difficulties and issues. Exactly. So as a central bank, we need to look at several aspects. We need to explore, for example, the impact on the cost of food and what it means for inflation. And as a banking supervisor, we need to make sure that banks manage the risks that can stem from biodiversity and nature losses and that they do so in an adequate manner. And on a bigger scale, we need to see how this can, all of these things can affect financial stability if shocks shake up many parts of the economy. So this, I think, clearly shows why this is part of our mandate, of our role. Yeah, it's clear. So you mentioned two channels and so you told us about the physical risk that was depicted with this example of the farmer. So what's the second one? What's the second aspect? Right. So the second aspect has to do with the fact that governments are not just sitting wildly by, but they look at these developments and they want to do something about it, fortunately. EU institutions have just reached the political agreement on what I would actually qualify as a landmark law, the biodiversity law, the European nature restoration law, to be exact, which is part of the wider biodiversity strategy and the key element of the EU Green Deal. And this law sets binding targets. So in a nutshell, each member state has to come up with measures to restore 20% of land and sea areas by 2030. And all ecosystems that are in need of restorations by 2050. And, well, you know, of course, I very much welcome this, especially because it goes beyond preserving nature. It goes actually into restoring nature. So let's imagine I'm a farmer again. So what does it mean for me? Well, it's actually pretty simple. Some of the areas in poor conditions might actually be my own land. So what can I do then to improve the soil, increase landscape diversity? I might have to plant hedgerows and trees to help restore my land. It might also be that I have to reduce or maybe even ban the use of pesticides. It could even mean that, you know, in the end I could not, you know, continue my business. In one way or the other, I will have to change the way I do my business and it might have a clear financial impact on my business and it might actually bring me in a situation that it will be more difficult for me to repay my loans and this, of course, that will affect also the bank. Now this we call transition risks. So we talked about the physical risks, the soil being degraded, no access to clean water. And I now gave you an example of a transition risk. That sounds worrying. I wonder, can you put some numbers to this? How big is this impact on the economy and on banks? Well, we are central banks so we like numbers and we look at numbers and we just actually published research on how exposed firms and banks are to nature services. We have never done work on this before so this is new. We have done lots on climate but not on nature. But here we did that and it's actually a very big project and colleagues looked at 4.2 million individual companies accounting for 4.3 trillion euro in corporate loans in the euro area. And what we found was that 70% of businesses, so 3 million companies depend on water, timber, sand or another natural service. So this is a huge number and there is a huge amount of money involved. So imagine the financial risk that comes with this. Imagine what it would mean for these businesses and also for the banks that lend to them. So this is looking at the firms but we also looked at the banks and here what we find, maybe not surprisingly, knowing the number of firms that actually depend on these nature related services but looking at the banks now, 3 in 4 loans on the books of banks are actually 2 firms that depend on one or more nature related services. And the study also clearly shows that banks are vulnerable to future biodiversity and nature services losses. So we looked at what happens to their credit portfolios and it is actually clear it would mean losses, real financial losses. And again, not small ones. Yes, the numbers are big, no? They're big. We also looked at the impact of future shocks and it was confirmed again that if we don't do anything now, if we don't invest in a transition, if we continue to put pressure on biodiversity and nature services, if we don't get fully aligned with the Paris goals, banks' losses could be almost 3 times higher than if we act now. So it's really urgent to do something basically. Exactly and for specific countries it's even worse. So for banks in Germany, Lithuania, Ireland and Belgium, losses can be even 5 times higher. Those are really big numbers. For our listeners, we will link to the paper in the show notes to this research so that people can really refer to that if needed. And this field of research is very new. Why is it important and what is DCB's role here? You know, I would say that to manage any time the risk properly, you first need to understand it. And this is true for our price stability task as well as for our role as a banking supervisor. So a first step is to see how exposed people, businesses, banks and the economy actually are to biodiversity and nature services loss. And we have made a good start with the research that I mentioned earlier. And actually I think that we are at the forefront of looking into this. But again, let me give maybe that makes it more tangible, some real examples. So think for example in terms of a fall in fish populations. And now of course this will impact the price of fish. And this in turn affects those who buy fish and those who sell it. So fisheries, supermarkets, restaurants and the people who work there. And we need to understand better how all this affects price stability and how it affects also the safety of banks. So second example, I think for example of something that we all think is just there in abundance, which is sand. It's the most mined mineral solid material on earth. And we use it to build our homes and other buildings. And actually we use far too much of it. And as sand becomes less available, this affects logically the cost of building our houses or businesses. And it also impacts banks that give building loans and it affects the economy at large. So again, you would maybe not think about it. But these are the kind of nature-related services that we used to take for granted as if it was us all there in abundance. Always there. And it's now. Now of course there are challenges. So let me mention some. Data limitations. The uncertainty around certain tipping points. How climate change and biodiversity and nature laws reinforce each other. And also the geographical spread. So we have still quite a long way to go to really understand what the effects are on our economy, how climate change and biodiversity reinforce each other. And the impact that business have on nature, service and biodiversity laws. So the biodiversity footprint of our firms. So yes, there are challenges. But we are not letting these limitations hold us back. In fact, we will actually publish a second part of our big study soon. So this study shows that the impact of companies on biodiversity laws is staggering. So the impact that think about this, the impact of European firms on nature is comparable to the loss and I'm going to throw a big number at you. It's comparable to the loss of 582 million hectares of pristine natural areas worldwide. How much is that? I mean it's huge. So this is about equal to 60% of European land area. Now this still upcoming soon to be published research also looks at the climate nature nexus as we call it. So so far financial risks from climate change and nature degradation are largely tackled as two independent issues. But it's actually very likely that the biggest impact on our economy will materialize as a combined effect of both. Okay, you mentioned that they reinforce each other. Exactly. So in short, because this was just a little preview, I would say keep an eye out for that soon to be published paper. Absolutely. And we invite everybody to do that indeed. Now I'd like to zoom in on banks and on our work as supervisors. We advise banks on how to manage their risk. In fact in 2020 we guided them on how to manage risk from climate and nature loss. And as you just mentioned, three out of four bank loans are exposed to biodiversity and nature service loss. And I'd like to repeat three out of four bank loans are exposed to biodiversity and nature service loss is huge. How can banks deal with that? So indeed we published the guide in 2020. Actually we embarked on a multi-year strategy. So we asked the banks to self-assess in 2021 and to come up with concrete action plans. And then in 2022 we closely looked at all the banks under our direct supervision. And they had not made enough progress. 25% had not yet assessed how exposed they are to climate risks. And 40% had failed to do so on biodiversity risk. Now we have seen some progress on biodiversity. The first banks have set capital aside for environmental risks. And this is actually a very good development. But there are also banks that have not complied with our deadlines to manage their climate and environmental risks. But there are banks that have not complied with our deadlines to manage their climate and environmental risks. And so we have started to ask them to remedy their shortcomings. And if they do not do so, they will have to pay a penalty for every day the shortcoming remains unresolved. Okay. Thanks, Frank. This really deserves attention. Before we wrap up, we always have a question for our guests. And that's for a hot tip on today's topic. So biodiversity loss. Frank, what's your hot tip today? Well, first of all, I want to say that I very much like this tradition. And second, I'm going to deviate a little bit from what I've done so far because I've never dared to recommend a book that I've actually not yet read. But since the book that I'm going to mention to you was recommended to someone whom I blindly trust. Okay. Who is a dear colleague here at ECB. Who is actually a climate scientist. And he was the first climate scientist who was ever hired by any central bank in the world. His name is Andre Seklar. So he recommended a book to me written by two authors, both called Timothy, Timothy Orwarden and Timothy Lenton. And the title is addressing tipping points for a precarious future. Okay. So my idea would be, I ordered the book. So it's on its way. My idea would be that the listeners, you know, I don't know what you're going to invite me back. But if you do, we might tell each other about the book. But why I chose it also is because of the tipping points. Tipping points are scary. Tipping points mean that something happens out there in terms of climate or biodiversity that we can just no longer turn back to. Yes, yes. You know, a book you can read and you can go back to an earlier chapter. A tipping point in nature or in climate means it's over. No returning points. No returning point. And some of these might already have been passed. Okay. So it's really a call on my part also for the urgency of the matter that we talked about today. We better try all we can to avoid reaching these tipping points. Absolutely, absolutely. Thank you so much, Frank. Sounds like an interesting read actually. I'll just repeat the title for our listeners. Addressing tipping points for a precarious future. And we will add the link in the show notes. So make sure you have a look at that. Thank you, Frank. Thank you so much. So this brings us to the end of this episode. I want to thank Frank Alderson, Executive Board Member and Vice Chair of the Supervisory Board. And dear listeners, check out the show notes, as I said, for more on this topic. You've been listening to the ECB podcast with Stefania Secola. If you like what you've heard, please subscribe and leave us a review. In the spirit of Europe, I'd like to end in Portuguese today and say, at the breath. Until next time, thanks for listening.