Financial authorities can play a role to to prevent catastrophic and irreversible loss of ecosystems
Central banks and financial supervisors are starting to grapple with the threat that nature loss poses to their mandates. The Network for Greening the Financial System (NGFS) recently suggested that focusing on specific ecosystems could help authorities to prioritize nature-related risks. Some ecosystems are subject to tipping points — nonlinear collapses in functioning across a critical threshold that could have globally catastrophic impacts. These require urgent focus, but their uncertainty, severity and irreversibility present a major challenge to policymakers.
In a new report, we examine some major ecosystem tipping points (ETPs), the economic activities driving them — such as climate change and deforestation — and consider what economic and financial risks could arise from crossing them. We argue that current efforts to model the impacts of ETPs may considerably underestimate risks. More broadly, more attention should be given to preventing their occurrence, as much as updated modeling.
Embracing double materiality could be a promising step forward — focusing on where financial actors are exposed to the economic activity directly pushing ecosystems towards tipping points. Addressing these pressures will ultimately require action beyond prudential and monetary policy, but financial policymakers are well placed to coordinate with ministries of finance, environment and industry to prevent catastrophic ecological risks.
Tipping points impact on climate- and nature-related financial risks
Tipping points in the Earth’s natural systems refer to critical thresholds beyond which relatively small perturbations can trigger abrupt, large scale and potentially irreversible changes. As human activities continue to exert unprecedented pressure on the planet, we are approaching these critical thresholds across multiple domains. Once crossed, tipping points can lead to profound and irreversible changes in the planet’s life-support systems that all societies depend on.
The concept of tipping points is crucial for understanding the risks posed by climate change and nature loss. What makes tipping points so concerning is their nonlinear dynamics. Small pressures may have minimal impacts initially. But as critical thresholds are approached, the system becomes increasingly sensitive to any additional changes, no matter how minor they may seem — the future does not behave like the past.
Once crossed, tipping points can lead to profound and irreversible changes in the planet’s life-support systems that all societies depend on.
Once tipping points are crossed, self-reinforcing feedback loops are triggered that accelerate transitions to vastly altered states. Complex systems characteristics like this make it very difficult to predict precisely when tipping may occur.
Tipping points are most well-known in the context of climate change. For example, the Greenland ice sheet will become more vulnerable to melting as global temperatures rise. Melting the ice sheet reduces the amount of radiation it reflects into space and lowers it into warmer air. This further accelerates melting and could lead to a runaway collapse with multimeter sea-level rises, even if global heating was halted.
Figure 1. At (a), an increase in pressure from a driver (e.g. regional temperature) causes minimal change to the system feature (e.g. forest cover). Close to the tipping point at (b), non-linearity leads the same amount of pressure to cause the system to lose resilience and change state. © Marsden / Ryan-Collins / Abrams / Lenton
Parts of the living world also contain the potential for devastating ETPs. Importantly, these are driven not just by climate change but also by other drivers of nature loss such as land-use change and pollution. The Amazon rainforest could rapidly transform into a (lower-carbon, lower-biodiversity) grassland under the combined pressures of deforestation and climate change. Corals are being pushed to their limits by ocean warming, acidification and local threats like pollution — without urgent mitigation, widespread bleaching and shifts to algae-dominated reefs are very likely.
The consequences would be catastrophic from ecological and societal perspectives. If tipping points are passed, systems will continue to collapse, even if pressures like global warming or deforestation are then eliminated. The risks are therefore high uncertainty, high impact, and essentially irreversible on the timescales necessary to avoid the worst impacts. As systems are interconnected, crossing one tipping point can also increase the likelihood of triggering cascades into other areas.
Ecosystem tipping points pose enormous threats to economic stability
In our recent report, we argue that ETPs need particular attention from policymakers focusing on how nature loss may impact economic and financial systems. While all tipping points pose potentially systemic risks, ETPs are important because ecosystems can collapse much more rapidly than ocean currents and ice sheets and their complex ecological dynamics render them subject to even more uncertainty than other types of tipping points.
We rely on a stable natural world for all economic activity. Beyond the intrinsic loss of losing such iconic environments, crossing tipping points will abruptly change the quantity and quality of contributions these critical ecosystems provide to societies and the economy. Sectors from agriculture and forestry to power and transport directly depend on the services offered by ecosystems facing tipping points, such as the Amazon rainforest, tropical peatlands in Indonesia and mangroves on the coastline of India. Those services include everything from pollination and climate regulation to rainfall cycling. Communities will face direct health risks from heat stress and fire pollution, as well an increased likelihood of acute shocks from disease and pandemics.
Figure 2. Losses to multiple ecosystem services in a high-magnitude way will cause substantial economic and financial risks. The financial system may play a role in amplifying risk through feedback effects, and by enabling economic activities linked to ETP drivers in specific ecosystems (double materiality). © Marsden / Ryan-Collins / Abrams / Lenton
Exposures are not limited to the jurisdictions in which these ecosystems can be found — a globalized economy and teleconnections across the Earth system means that initial impacts can spread rapidly through value chains and weather patterns. Critically, ecosystems such as the Amazon, tropical peatlands, and mangroves currently sequester large volumes of carbon — at least 20 years of current annual CO2 emissions. This capacity could be damaged relatively rapidly through dieback and fires should tipping points be crossed. This is not properly reflected in the Earth system models used for future climate change projections. This means ETPs would lead to climate impacts occurring much sooner than currently predicted.
If we consider risk as the combination of exposure, hazard and vulnerability, then we can see that ETPs increase levels of both hazard and vulnerability, potentially over very short timescales. Hazards increase because ETPs will amplify climate change, raising the likelihood of acute shocks such as droughts, floods, and storms worldwide. Our vulnerability to such shocks will also rise because ecosystems provide resilience to hazards – for example, coral reefs and mangroves currently protect at least $400 billion worth of built assets from extreme storms. These sorts of losses simply cannot be substituted through technology or trade, which is a common assumption in macroeconomic models that aim to link nature loss to the economy. Whether we breach ETPs determines in part the magnitude of all environmental related risks.
Quantitative approaches can always be improved but policymakers must recognise their fundamental limitations
So far, the main approach taken by financial authorities on nature loss has been to try measuring risks in order to manage them. This has produced pioneering findings that demonstrate how materiality of nature to our financial systems. The Banque de France found in 2021 that the entire non-financial portfolio of the French financial system was dependent, in some way, on nature. But attempts to more dynamically quantify how tipping point shocks could propagate to economies show very mild results — one study found that the total collapse of three ecosystem services would only cost 2.3% of global GDP annually by 2030 relative to a “no tipping point” scenario. This conflicts with the scientific evidence that crossing multiple tipping points would be catastrophic.
Policymakers can explore modeling frameworks that better account for the fact that many, if not all, of nature’s contributions cannot be substituted.
There are many ways that financial policymakers can — and should — improve these analyses. For example, policymakers can explore modeling frameworks that better account for the fact that many, if not all, of nature’s contributions cannot be substituted. The equations, known as damage functions, that stylise tipping-point dynamics in models of chronic climate risks can be updated. Collaboration with Earth systems scientists, as well as more diverse schools of economic thought, will be key.
However, ETPs will remain subject to fundamental uncertainty as we do not know all their ecological complexities, never mind the infinite ways they could impact our economy. Such studies should remain exploratory – policymakers cannot solely rely on them to steer mitigation action.
Double materiality: a promising intervention point
If looking at ETPs through the lens of financial materiality faces limitations, what other options do financial policymakers have? There is a strong case that double materiality could be promising. In our report, we show that while ETPs will have global impacts, a relatively concentrated group of economic sectors are implicated in local pressures on ecosystems that are driving them towards tipping points. For example, around two-thirds of deforestation in the Brazilian Amazon has been attributed to beef and soy production. Industrial plantations of oil palm and pulpwood account for over 50% of historical deforestation on peatlands. Along with rapid reductions in greenhouse gas emissions, eliminating these pressures on ecosystems is urgent to reduce the risks of collapse.
As well as exploring how alternative models enhance our understanding of the financial materiality of ETPs, policymakers should map where financial actors may be indirectly contributing to the risks through their capital allocation decisions — in other words, double materiality. Recent studies show that financial flows to companies in forest-risk sectors are substantial, with a lack of sufficient safeguards suggesting they are not being managed as transition risks.
There is a clear rationale for financial authorities to investigate further. Individual financial institutions are not acting in line with the system-wide financial stability concerns that would arise if ETPs are crossed. Importantly, the data to do this is already available, though more work is needed to understand which finance is most linked to critical ecosystems such as boreal forests and mangroves.
Finance to the entities most implicated in ecosystem destruction is known to proceed across national borders, including through tax havens as well as “shadow” companies.
Identifying these financing activities could break policymakers out of “analysis paralysis.” A next step would be to explore how credit, (macro)prudential and monetary policy tools could be best utilized as part of a precautionary approach that prioritizes steering us away from catastrophic tipping points.
Precautionary financial policy is not a panacea
Of course, financial (and monetary) policy will not be sufficient, alone, to eliminate negative pressures on critical ecosystems and prevent tipping points from being crossed. Problems such as deforestation are notoriously thorny. Behind the proximate causes of land-use change are a multitude of underlying drivers operating at multiple scales. Finance to the entities most implicated in ecosystem destruction is known to proceed across national borders, including through tax havens as well as “shadow” companies.
This underscores the need for international collaboration through institutions such as the NGFS, the Bank for International Settlements and the International Monetary Fund, as well as a clear role for ministries of finance, environment and industrial policy. Central banks and financial supervisors – given their medium- and long-term view of economic and financial stability – are well placed to coordinate with these actors, and indeed will increasingly need to in order to achieve their primary mandates as the climate and nature crises bite.
National strategies to define an ecological transition must ultimately be led by governments. But the alignment of monetary and supervisory tools with these frameworks is essential and is likely to be a necessary precursor to achieve global climate and biodiversity targets and preserve the functioning of our planet’s most critical ecosystems.
Featured photo: Melting Greenland ice sheet
