The ‘Era of Pandemics’, Biodiversity Loss and Financial Institutions
Most banks today have some form of environmental risk management system integrated into their credit approval process. One often poorly understood subcomponent of the environmental risk management system is the assessment of so-called “biodiversity impacts” of the activities being financed by the bank. In this context, biodiversity impacts refer to impacts on natural undeveloped areas, big and small – such as forested areas, mangroves, savannah grasslands and the like – as well as the animals, plants and ecological networks which they collectively form. Perhaps because it is poorly understood, the assessment of the biodiversity impacts of financed activities is often only given token consideration by financial institutions during the credit approval process, other than perhaps where the activities may impact on national parks and similar areas protected by law.
In fact, a frequent question that sustainability specialists receive from banks’ commercial teams and Chief Risk Officers is whether environmental issues such as biodiversity loss really pose a material risk to banks; or whether this is simply something that needs to be done to placate certain investors of a particular ideological persuasion.
What is often difficult to convey in these conversations is that the risks associated with biodiversity impacts are not always related to the creditworthiness of a specific loan or with a bank’s reputation but are arguably even more significantly associated with the mitigation of much broader – and serious – systemic socioeconomic risks, which can have dire economic consequences for financial institutions. A prime example of a systemic risk associated with biodiversity loss is the threat of infectious disease pandemics such as COVID-19, and the resultant impact on the economy.
The “Era of Pandemics”
This is not merely a theory. Ebola, SARS, MERS, bird flu and now COVID-19 are all real-world examples of what happens when wildlife, humans and livestock interact in ways driven, at least in part, by biodiversity loss[1]. And, increasingly, it appears that outbreaks of such infectious diseases like those mentioned are significantly on the rise. Indeed, some scientists are now warning of an “Era of Pandemics” driven by the nexus of biodiversity loss, infectious pathogens and globalisation.
The impact that such pandemics, driven by biodiversity loss, may have not only on the financial performance and economic valuation of financial institutions, but also on the lives of the people who work at these institutions and their families, has been brutally driven home over the past two years. The COVID-19 pandemic is therefore a pointed reference marker of just what sustainability specialists have in mind when they speak of the systemic socioeconomic risks associated with biodiversity loss.
Scientists, some of whom have been speaking of this risk for decades prior to COVID-19, argue that alongside the development of vaccines and other technological solutions, the risk of future pandemics should be reduced by controlling deforestation, minimising biodiversity loss, and curbing the wildlife trade in animals that can host dangerous pathogens.
Barriers to action by financial institutions
Financial institutions, of course, have a role to play in this solution, not least by giving more serious weight in the credit risk process to the biodiversity implications of financed activities. This may, for example, entail placing more stringent requirements on property developers to minimise or offset the impact of a proposed development on natural areas within the developmental footprint.
However, even if the importance of biodiversity conservation to the economic wellbeing of banks is understood and accepted by the financial institutions’ commercial leadership, there remain very real challenges deterring the effective incorporation of biodiversity impacts into the broader credit approval process. Namely, a fear that other competing financial institutions will not be bound by such considerations and that this may lead to a loss of business and market share. Banks’ leaders may argue, not unjustly, that this approach will only work if everyone acts responsibly.
This economic problem is well-known as the “Tragedy of the Commons” (so termed in 1833 by British economist William Forster Lloyd). In the Tragedy of the Commons, even where everyone understands that they would be better off cooperating to avoid a negative economic outcome, individual market players are nevertheless driven towards self-defeating behaviour by a fear of others taking short-term economic advantage of their own responsible behaviour.
Rising to the challenge
It is arguably one of the challenges of our time to see whether we can rise above the challenge of the Tragedy of the Commons. It is therefore incumbent upon the leadership of financial institutions to find constructive means to alleviate this fear of competing firms taking advantage of the situation, other than by merely gaming the system and making a token effort at solving the issue.
Such constructive action should take the form, not least, of actively engaging with regulators to support a collective raising of the bar and level playing field for all players in the market regarding environmental risk screening (including biodiversity impacts) by financial institutions, through, for example, the promotion of sustainable banking principles, as has been done by the central banks in Nigeria and Ghana.
It should also involve proactively seeking opportunities to partner with local and international stakeholders to invest in and enhance the ecological integrity of natural systems in their geographic regions of operation, for example, by actively supporting sectors such as eco-tourism, and by supporting regulators who seek improve environmental standards for the banks’ customers.
Finally, management should perceive the market advantage in being seen as a leader in setting out a sustainable vision for the economic development trajectory of their regions of operation and by working together with investors who stand ready to assist those financial institutions who are committed to this challenge.
Compiled by Elan Theeboom, ESG Specialist
See for example:
[1](a) Scientific American: Destroyed Habitat Creates the Perfect Conditions for Coronavirus to Emerge – COVID-19 may be just the beginning of mass pandemics. https://www.scientificamerican.com/article/destroyed-habitat-creates-the-perfect-conditions-for-coronavirus-to-emerge/
b) Why deforestation and extinctions make pandemics more likely. https://www.nature.com/articles/d41586-020-02341-1
