Financial Institutions & Nature Risk
Financial institutions occupy a unique position in the nature-related risk landscape. Unlike companies in extractives or agriculture that create direct biodiversity impacts, banks, insurers, and asset managers face nature risk primarily through their portfolios: the loans they extend, the equity they hold, and the insurance policies they underwrite. A bank that finances a palm oil company is financially exposed to that company's nature-related risks, even if the bank itself operates from an office building in a city centre. This "transmitted" or "financed" nature risk is the central analytical challenge for financial institutions implementing the TNFD framework.
How Nature Risk Transmits Through Financial Portfolios
TNFD identifies two primary channels through which nature-related risks affect financial institutions: physical risk transmission and transition risk transmission.
Physical risk transmission occurs when ecosystem degradation reduces the economic value or viability of activities that financial institutions have funded. A bank with significant loan exposure to agricultural companies in water-stressed regions faces credit risk if drought and aquifer depletion reduce those companies' ability to repay. An insurer with agricultural insurance portfolios faces underwriting risk as yield volatility increases due to pollinator decline and soil degradation. An asset manager holding equity in a mining company faces market risk if that company's operations are constrained or its valuation is impaired by biodiversity impacts.
Transition risk transmission occurs when policy changes, regulatory requirements, or market shifts driven by nature-related concerns reduce the value of portfolio assets. The EU Deforestation Regulation imposes compliance costs and potential market access restrictions on commodity companies, which transmits as credit or equity risk to their lenders and investors. Tightening permitting requirements for mining operations in sensitive ecosystems increase project development costs, affecting the economics of mining projects that banks have financed.
Nature-Related Financial Risk Categories for Financial Institutions
TNFD identifies four nature-related risk categories particularly relevant to financial institutions: (1) Credit risk - borrowers' creditworthiness and ability to repay is impaired by nature-related physical or transition risks; (2) Market risk - the value of traded financial instruments declines due to nature-related factors affecting issuers; (3) Underwriting risk - insurance claims increase or insurance pricing becomes unviable as ecosystem degradation increases the frequency and severity of insured events; (4) Systemic risk - widespread ecosystem degradation threatens macroeconomic stability in ways that affect entire financial systems, not just individual counterparties.
TNFD Application for Banks
For commercial and investment banks, the TNFD LEAP approach applies primarily at the portfolio level: identifying which loan or investment portfolios have the highest nature-related risk exposure, evaluating the nature dependencies and impacts of counterparties in those portfolios, assessing the financial risk that flows from those dependencies and impacts, and preparing disclosures that communicate material nature-related financial risks to investors and regulators.
Sector-based portfolio screening is typically the first step: banks categorise their loan books by sector and identify which sectors (agriculture, mining, infrastructure, real estate in ecologically sensitive areas) have the highest nature-related risk exposure. The ENCORE tool (Exploring Natural Capital Opportunities, Risks, and Exposure), developed by UNEP-WCMC and Global Canopy, provides a structured approach to assessing which economic sectors are most dependent on and have the greatest impact on different ecosystem services. Banks have used ENCORE to prioritise which parts of their loan portfolios require deeper nature-related risk assessment.
Analogy: Nature Risk as a New Credit Variable
Traditional credit risk assessment evaluates a borrower's ability and willingness to repay a loan based on financial performance, leverage, and business model quality. Nature risk adds a new category of variables: how dependent is the borrower's business on ecosystem services that are degrading? How exposed is the borrower to regulatory or market changes driven by nature loss? Just as a bank already prices climate risk into loans to carbon-intensive sectors (recognising that energy transition policies may strand fossil fuel assets), nature risk analysis asks banks to price the risk that ecosystem degradation or nature-related regulation constrains the business models of borrowers in nature-dependent sectors.
TNFD Application for Asset Managers and Institutional Investors
Asset managers applying TNFD assess nature-related risks and opportunities across their investment portfolios, with the goal of understanding which holdings are most exposed to nature-related financial risks and identifying opportunities in businesses that provide nature-positive solutions. Engagement with portfolio companies - encouraging them to implement TNFD disclosure and adopt nature-positive strategies - is a key mechanism for asset managers to reduce nature-related portfolio risk over time.
Institutional investors, including pension funds and sovereign wealth funds, are increasingly recognising that nature loss represents a systemic financial risk that cannot be diversified away. The Finance for Biodiversity Pledge, signed by over 150 financial institutions representing more than EUR 21 trillion in assets under management by 2024, commits signatories to assessing and disclosing their biodiversity impact and to engaging with companies in their portfolios on nature. Many of these institutions cite TNFD as the primary disclosure framework they will use.
TNFD Application for Insurers
The insurance industry faces nature-related risks on both sides of its balance sheet: on the liability side, through increasing claims from nature-related physical events (floods, crop failures, coastal damage from reef degradation), and on the asset side, through nature-related risks in their investment portfolios. The Nature Action 100 initiative and the UNEP Finance Initiative's work on nature and insurance provide frameworks for insurers to assess and disclose these risks.
Coastal insurers provide a particularly clear illustration of nature-related risk transmission. Mangrove forests and coral reefs provide coastal protection services worth an estimated USD 65 billion per year globally, reducing wave height and storm surge impacts on coastal properties. As these ecosystems degrade, the physical damage from coastal storms increases, driving higher claims for coastal property insurers and making some coastal areas uninsurable.
Portfolio Screening Tools and Approaches
| Screening Approach | Description | Best For |
|---|---|---|
| ENCORE Sector Screening | Maps economic sectors to ecosystem service dependencies and impacts to identify high-risk sectors in loan books or investment portfolios | Initial hotspot identification across diversified portfolios |
| PBAF (Partnership for Biodiversity Accounting Financials) Methodology | Quantifies biodiversity footprint of financial portfolios using sector-based impact factors | Aggregate portfolio-level biodiversity disclosure |
| Biodiversity Impact Analytics (BIA) | Company-level biodiversity impact assessment aligned with Mean Species Abundance metrics | Deeper assessment of high-risk counterparties |
| TNFD LEAP at Portfolio Level | Applies the LEAP phases to a financial portfolio: Locate risk geographies, Evaluate counterparty dependencies, Assess financial risk, Prepare disclosure | TNFD-aligned comprehensive disclosure |
Key Takeaways
- 1Financial institutions face nature-related risks primarily through their portfolios rather than through direct operations, with risk transmitted via two channels: physical risk (ecosystem degradation impairing borrower viability) and transition risk (regulation or market shifts reducing portfolio asset values)
- 2TNFD identifies four nature-related risk categories for financial institutions: credit risk, market risk, underwriting risk, and systemic risk
- 3The ENCORE tool enables banks and asset managers to prioritise which parts of their portfolios require deeper nature risk assessment based on sector-level ecosystem service dependencies and impacts
- 4Over 150 financial institutions representing EUR 21 trillion in assets have signed the Finance for Biodiversity Pledge, committing to biodiversity impact assessment and portfolio engagement
- 5Coastal insurers face direct nature-related underwriting risk as mangrove and reef degradation removes natural protection for coastal properties, increasing storm damage claims