Nature and financial institutions in Africa: A first assessment of opportunities and risks

Africa’s climate resilience can be strengthened by redefining its economic model to leverage natural capital and designing financial systems to redirect critical nature-based investments.

This report applies, for the first time, a quantitative risk assessment and stress-testing framework for financial institutions to the opportunities and risks relating to nature. It builds on the pioneering nature-related risk assessments undertaken by Banque de France and De Nederlandsche Bank (DNB), which estimated the share of assets held in the French and Dutch financial systems considered at high risk from nature loss. The analysis in this report extends this approach to quantify how the value of financial assets would change under scenarios of future action on climate and nature. The scenarios define a series of plausible narratives and goals, and the assessment considers how the actions needed to reach those goals would impact the performance of financial portfolios.

Sidebar

The emerging findings offer proof that it is possible for financial institutions to assess nature-related opportunities and risks and that these are material. Globally, this report is the first to present the results of applying the Locate, Evaluate and Assess stages of the Taskforce on Nature-related Financial Disclosures’ (TNFD) LEAP approach to a private financial institution’s portfolio and to a national financial system. In doing so, it offers an example of what is feasible in Africa, and thus of what is feasible across much of the world. It also shows that nature-related opportunities and risks are material in Africa, a region with high growth opportunities and globally important natural capital.

This assessment describes the changes in asset values and company-level financial performance that might result from nature-related opportunities and risks. Using new data sets and tools, this study evaluates the degree to which companies impact and depend on nature, and how nature affects their business activities, including their supply chains. It estimates how these factors influence average company-level financial performance over time, sector by sector, and country by country across Africa, before applying these results to a high-level stress test. The final outputs are estimates of changes in expected losses from lending and changes in equity prices, aggregated into the portfolios of several leading African commercial financial institutions. It also estimates these changes for the national aggregate lending portfolios of six African countries.

The case for action

If current trends continue, Africa may breach environmental tipping points causing large-scale physical risks for financial assets. The transgression of tipping points, such as the complete loss of pollinators or dieback of coral reefs, would create severe costs for businesses and is becoming more likely, both globally and in Africa. For example, research suggests the loss of 20-30 percent of remaining forest cover in the Amazon rainforest would trigger an irreversible conversion of all remaining forest to savannah. Equivalent figures are not yet available for the Congo Basin though studies have confirmed that projected future deforestation in Western and Central Africa is likely to disrupt the West African monsoon, dramatically affecting rain-fed agriculture, in particular maize crops north of the equator. 25 percent of African countries, including South Africa and most of Northern Africa, are already water-stressed today. Acute tail risk events like these have the potential to make business practices that are highly dependent on nature infeasible and strand assets in affected areas. Examples include rain-fed agriculture, pharmaceutical research, and ecotourism.

The modelling framework does not capture these tipping points and underestimates nature-related physical risks. Across all the portfolios considered, the changes in asset value driven by physical risk exposure are limited. However, they are underestimates for four reasons. First, current frameworks model risks from incremental changes in ecosystems, and do not model the large-scale tail risks associated with crossing environmental tipping points. Second, the assessment considers average risk at the country level, masking a broad distribution of impacts across sub-national locations and companies. Risks for some individual locations and companies will be substantially higher than the average. Third, the assessment evaluates a subset of physical risks considered to be the most material and feasible to model. There are also physical risks that are not modelled such as the loss of natural water filtration or flood and storm protection, and these could be material. Fourth, similar to climate change, the physical risks of nature loss will intensify over time, with more severe impacts beyond 2050, the time horizon considered in this analysis.

Mounting physical risks make global consumer and policy action to address the nature crisis more likely. The fast pace at which nature is degrading and the severe consequence of environmental tipping points have led many researchers to proclaim a state of nature crisis. Policymakers and regulators around the world are already acting to address nature loss and are cooperating to facilitate a ‘net-zero and nature-positive’ transition—a transition which ensures a future state of nature (including biodiversity, ecosystem services and natural capital) which is greater than the current state. For example, in 2021, summit statements from leaders of the G7, G20, and COP26 committed to a ‘net-zero and nature-positive transition’.

Asset value results

Ambitious consumer and policy actions taken to halt net nature degradation will substantially impact the financial institution portfolios considered, with changes in the value of equity portfolios ranging from +2 to -5 percent by 2030 (Exhibit 1) and of loan books ranging from +0.3 to -0.6 percent (Exhibit 2). These changes are large given the limited exposure to nature-intensive sectors such as agriculture and extractives across the portfolios. As mentioned above, they also reflect average impacts. Individual subsectors, locations and companies can experience much larger impacts. Gains are driven by exposure to high-growth agricultural commodities which benefit from the expansion of alternative proteins (such as sugarcane and pulses) which have lower impacts on nature than traditional proteins. Losses are driven by exposure to slower-growth agricultural commodities linked to pastoral farming (such as corn and tropical roots), exposure to deforestation-linked minerals, and to a lesser extent, exposure to related downstream sectors, such as manufacturing, wholesale trade, and retail trade. Losses can be offset by diversifying portfolios to include companies with less nature-intensive practices and by focusing on areas of opportunity that may emerge in a nature-positive scenario.

By 2030, total equity value could fall by up to 5% under ambitious action to reverse nature loss.
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By 2030, total loan book values could change by +0.3% to -0.6% under ambitious action.
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Looking specifically at the agriculture and extractives sectors, expected gains and losses by 2030 are an order of magnitude higher, representing material shifts in value that require immediate attention. For equity, changes in value are significant, reaching between -2 percent and -5 percent for agriculture in most countries, and between +1 percent and -4 percent for extractives. In the most extreme examples, the value of agricultural investments increases by +55 percent in one country and falls by -22 percent in another. For lending, changes in loan book value can also be large, reaching between +5 percent and -3 percent for agriculture (Exhibit 3), and +0 to -3 percent for extractives. Again, these results are averages for a country-sector combination. The impacts for some individual subsectors, locations and companies are significantly higher.

By 2030, lending to agriculture could see gains and losses between +5.4% and -3.2% under Climate + Nature Now.
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For the most exposed lending portfolios, nature-related risks in agriculture and extractives would roughly double expected losses due to credit risk by 2030. Based on our experience in working with the financial sector, diversified private banks would typically expect losses from traditional credit risks (unrelated to climate or nature) of around 3-5 percent over a ten-year period. This is roughly in line with the highest estimated losses from lending to agriculture and extractives as a result of nature-related risks, presented above. This represents a substantial decrease in the profitability of lending to these sectors unless these risks are carefully managed, for example, through stewardship.

Nature-related risks in agriculture and extractives are of the same (large) scale as climate-related risks in manufacturing, chemicals and extractives. Equity values closely track changes in the expected future flow of profits. Based on our nature-related risk assessment, profits in agriculture and deforestation-linked extractives will likely fall by 20 percent and 15 percent respectively in 2050 under our most ambitious scenario 9 (Exhibit 4). By contrast, climate-related risk assessment work by Vivid Economics and Planetrics has shown that in a 2050 net-zero scenario, manufacturing, chemicals, and extractives would see profit losses in 2050 of roughly 10 percent, 15 percent, and 25 percent respectively. For both nature and climate, this is primarily driven by transition risk.

Nature-related risks in deforestation-linked extraction and agriculture are of a comparable scale to climate-related risks in manufacturing, chemicals and extractives.
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Risks and opportunities driving asset value

If current trends continue, water stress across Africa would make agricultural production in the worst affected areas significantly more expensive by 2030. As already high levels of water stress worsen in the future, countries that face the highest pressure on limited water resources may consider methods to manage access to water. For agricultural businesses, this could increase the unit production costs of several agricultural commodities by +20 to +40 percent in 2030, relative to a baseline scenario which does not account for these risks. Without mitigating action, this would create large knock-on increases in commodity prices, often between +15 and +30 percent, affecting both downstream businesses and consumers.

Projected changes in land use between now and 2030 would affect the population of species that attract tourists in Africa and hence the financial performance of ecotourism. In this respect, Eastern and Southern African countries are at highest risk, as they account for a large share of tourism activity and are projected to see the fastest rates of change in land use. As mentioned above, if environmental tipping points linked to tourism are reached, such as the dieback of coral reefs in South-eastern Africa, impacts on demand and profits would be severe.

The need to mitigate these physical risks and preserve space for nature would require supply-side adjustments in land-intensive industries, often increasing production costs. Areas that are afforested, reforested, or become protected would no longer be available for agriculture. As a result, farmers would intensify yields to meet rising food demand. The investment in intensification would increase unit production costs in 2030, often by +5 to +20 percent relative to a baseline scenario. Over time, yield improvements would bring unit costs down, resulting in lower-than-baseline costs by 2050. The highest levels of intensification would occur in Central and Eastern Africa, where deforestation pressures and biodiversity value are high. In extractives, if export markets introduce deforestation standards such as those under consideration in the European Union, deforestation associated with gold and copper could become a market access risk. In addition, regulators may require businesses to restore affected land. Although the additional costs might be small through 2030, they could reach -2 to -33 percent of baseline unit production costs by 2050. In the food sector, in which local demand is predominantly met by local supply, consumers will bear the rising cost of production, leaving profit margins in the food business largely unchanged. For minerals, the incidence of cost pass-through may be lower, leaving producers and asset owners to bear a greater share of rising costs.

Shifts in food demand can reduce the nature impact of the food system and make room for the nature-positive transition. Based on existing literature, discouraging diet shifts towards meat and dairy and reducing food waste would be key levers to significantly reduce the future nature- and climate-impacts of the African food system. This would decelerate growth in food demand, primarily driven by population and income growth, and relieve pressure on the food system. Staple grains used for livestock feed would be most affected, with compound annual growth rates in demand falling substantially under the most ambitious scenarios from +3 percent to +1 percent. By contrast, alternative proteins would offer growth opportunities for agribusinesses. With ambitious action, aggregate profits in 2050 from relevant crops—such as pulses and sugar crops—would be +150 percent higher than baseline amounts. Looking at agriculture as a whole, aggregate profits would not grow as fast as they do in the baseline scenario, with profits -1 to -3 percent below baseline in 2030, and -10 to -23 percent below baseline in 2050. Put differently, aggregate profits would increase by +365 percent between 2020 and 2050 in our most ambitious scenario, compared to +470 percent in the baseline. This difference primarily reflects moderated increases in demand rather than reduced profit margins. This demonstrates that growth prospects would still be strong and robust in Africa, even with ambitious action to reduce and reverse net nature loss across the continent.

Practical management of nature-related opportunities and risks

Financial regulators and supervisors are moving towards bringing nature-related risks into the scope of financial regulation. In March 2022, the Network for Greening the Financial System (NGFS), representing 114 central banks and financial supervisors, concluded ‘that nature-related financial risks should be considered by central banks and supervisors for the fulfilment of their mandates’. In the same month, the Taskforce on Nature-related Financial Disclosures (TNFD) released its beta framework, laying the foundation for how businesses across the world—including the financial sector—might be expected to manage and disclose their actions on nature.

For African financial institutions, this presents several challenges given current capacity, processes and guidance:

  • Limited capacity: 80 percent of the institutions we engaged with are building out their climate risk capabilities and have not allocated capacity to take on nature. It is not yet clear how to effectively integrate nature with climate thereby minimizing the internal resources required to act on nature.
  • Lending to sectors with indirect exposure: The portfolios we examined had significant exposure to sectors with indirect and complex exposure to nature-related risks and opportunities, such as financial services (up to 20 percent in some cases) and tourism-related industries (up to 7 percent). The ways in which these sectors impact or depend on nature are not yet well understood.
  • Counterparty data availability: The data required for assessments are not routinely collected from counterparties. For example, none of the institutions we examined collected data on the location of physical assets in a standardized way across industries. Financial institutions cannot close this data gap by purchasing third-party data, as datasets do not yet comprehensively cover non-listed businesses. As a result, institutions can only perform a coarser sector-level assessment. It is also challenging for financial institutions to understand and assess complex tail risks associated with highly localized tipping points.
  • Attracting skills and talent: Financial institutions reported difficulty in recruiting staff with the right skills and experience for nature-related oversight. Requirements include proficiency with spatial data, understanding of scientific physical processes, and the ability to work across several departments including sustainability, financial risk and compliance.
  • Regulatory expectations and support: Financial institutions indicated that it would be easier to secure internal investment to develop nature-related oversight capacity if there are clear signals that such oversight will become a regulatory requirement. Regulators have not yet set a timeline for when they may implement the recommendations of the NGFS on nature-related risks.

Options for action

In preparing to address nature-related risks and comply with any future regulation, financial institutions can:

  • Consider climate and nature together from the start. Build integrated climate- and nature-related risk assessment and management processes. Integration makes both approaches more robust (due to climate-nature interactions), reduces overall cost, and alleviates capacity pressures.
  • Engage with the TNFD and other key actors. Through engagement, financial institutions can infuse frameworks such as the TNFD’s framework with practical considerations for their application in Africa. Engagement can reflect each organization’s own experience with nature-related risks and opportunities. High-priority topics raised in our working group focused on how to overcome the barriers discussed above, such as guidance on what data to collect and how to assess exposure for financial services and tourism.
  • Link training and capacity with climate. To tackle difficulties in recruitment, organizations can build the skills of their current staff. Many of the same skills are required for climate- and nature-related oversight, so capacity can be built for both within the same team.
  • Upgrade support systems. More data will be needed on the sectoral and geographical distribution of clients’ revenues, the location of clients’ operations, the state of local ecosystems on which they depend, and the actions being taken to address the clients’ impacts and dependencies on nature and its services. Many of the data needed for climate assessments are also needed for nature, and so data collection strategies can address both simultaneously.
  • Support customers. Customers and investees will need support to navigate the net-zero carbon and nature-positive transition. This includes providing advice and expertise to support clients to understand and manage nature-related risks as well as access to capital for investment.

Financial regulators, framework issuers, policy-makers and data providers can play a pivotal role. Regulators can clearly communicate their plans to integrate climate and nature risk management and a timeline for implementing the NGFS recommendations on nature-related risk. They can work together to provide guidance to the private sector, including how to deal with issues specific to African financial systems, such as working with currently available data. They can examine how this would change micro-prudential supervision frameworks such as supervisory review processes, disclosure templates, and minimum capital requirements. Framework issuers and standard-setters—including but not limited to the TNFD—can follow structured piloting processes covering each of the most important sectors and asset classes in Africa. In a similar way to regulators, policy-makers can outline in advance the future direction of policy to protect and restore Africa’s natural capital, in order to help financial institutions anticipate medium- and longer-term risks. Finally, data providers can engage with financial institutions and leverage new AI-driven technologies to solve data gaps, such as access to data on private (non-listed) companies.

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