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TitelManaging nature-related financial risks: a precautionary policy approach for central banks and financial supervisors

This paper addresses the question of how financial authorities should respond to environmental threats beyond climate change. These include biodiversity loss, water scarcity, ocean acidification, chemical pollution and - as the Covid 19 pandemic has clearly shown - the transmission of zoonotic diseases. We first provide an overview of these natural financial risks (NRFR) and then show how the financial sector is exposed to these risks and how it contributes to their development both through its lending and through the spread and amplification of financial shocks. We argue that the NRFR - because it is systemic, endogenous and subject to "radical uncertainty" - cannot be adequately managed by "market-fixing" approaches based on disclosure of information and quantitative risk estimates. Instead, we propose that fiscal authorities adopt a "precautionary policy approach", which makes greater use of qualitative risk management methods to support a controlled regime change towards a more sustainable capital allocation. One starting point would be to identify and exclude clearly unsustainable activities (e.g. deforestation) whose financing should be prevented by micro- and macro-prudential policy instruments. Monetary policy instruments such as asset purchase programs and collateralized operations, as well as central banks' own funds, should exclude assets associated with such activities.


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