Nature at risk: Implications for the euro area economy and financial stability
European Central Bank, Occasional Paper Series No 380
Degraded ecosystems undermine productivity, disrupt supply chains and heighten
vulnerability to shocks, creating risks for the real economy and the financial sector.
Biodiversity loss and ecosystem degradation also pose a growing risk to price
stability, with increasing evidence that ecosystem shocks contribute to inflationary
pressures in the euro area. This paper moves from dependency mapping to a risk-
based assessment of the euro area economy and banks, applying the nature value-
at-risk (NVaR) framework, which links biophysical shocks to ecosystem services with
sectoral-production functions. Water-related risks, including flood protection, surface
water and groundwater scarcity, and water quality, emerge as the most material for
the euro area economy. Surface-water scarcity alone could expose up to 24% of
euro area output to risk under a drought event with a 100-year return period. A
complementary endogenous-risk analysis that was conducted, quantified the extent
to which euro area firms and banks may contribute to the very ecosystem
degradation on which their activities depend, creating feedback loops that could
amplify financial risks over time. The results showed material feedback loops
between ecosystem degradation and banks’ own portfolios, with water-related risks
being the dominant transmission channel. Overall, this study takes a first step
towards the identification of risk hotspots and provides a more robust assessment of
nature-related risks than prior studies. It also discusses the remaining data gaps and
methodological constraints, and outlines the next steps to be taken, as a priority, to
address this.