Financial sector must wake up to risks linked to deforestation

Central banks, financial regulators and supervisors must urgently put in place adequate measures to lessen the finance sector’s significant contribution to global deforestation and ecosystem conversion, warns a new guidance document, Deforestation and Conversion: An introductory guide for central bankers, financial regulators and supervisors, published by WWF today. Despite the well-known consequences, funds keep streaming into destructive sectors. Monetary, regulatory and supervisory measures are needed to address the financial risks deriving from these investments, as well as the impacts on ecosystems.

Pablo Pacheco, Lead Scientist, WWF Forest Practice, says: “The global economy is dependent on nature and therefore exposed to the financial risk of short- and long-term nature loss. This is why central banks, supervisory and regulatory authorities should internalise the associated risks of nature loss in monetary policies and operations.”

Maud Abdelli, WWF’s Greening Financial Regulation Initiative Lead, says: “Central banks, financial regulators and supervisors are not meant to replace any governmental action but they should collaborate with policy makers and play their part. The less the financial system is prepared to adapt to regulations and preferences that aim to halt deforestation and conversion, the more difficult it becomes to prevent its instability.”

To reduce the financial risks posed by climate change and nature loss, WWF calls on central banks, supervisory and regulatory authorities to address the root causes within their activities and portfolios. This involves taking action to limit financial flows going towards activities responsible for deforestation, and ensuring investment portfolios are not contributing to the exacerbation of climate change and nature loss. By doing so, they can significantly reduce financial risks associated with environmental degradation.

One of the most important factors contributing to climate change and nature loss is land use change, 48% of which is related to deforestation and conversion of other ecosystemsfor example to turn previously forested land into agricultural land. But the risk goes beyond the environmental impacts: Deforestation and land use conversion are the source of physical and transition risks that affect the economy, and may lead to the collapse of the entire financial system. Yet, financial institutions responsible for allocating resources to sectors linked to deforestation fail to recognise this risk and consequently to undertake efforts to eliminate commodity-driven deforestation.

As of October 2022, $6.1 trillion USD was given by financial institutions to 350 companies linked to deforestation, according to Global Canopy. Finance keeps flowing towards the main driver of deforestation, namely agricultural expansion.

The EU Regulation on deforestation-free products, which became effective in June 2023, aims at eliminating the deforestation and forest degradation that is caused by EU consumption and production, by requiring companies to prove that products to be placed on the EU are deforestation-free. While financial institutions are not directly covered by the regulation, the European Commission has an obligation to assess the need to include financial institutions within the scope of the regime by 30 June 2025.