Nature at risk: Implications for the euro area economy and financial stability

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 functions1. 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. JEL Classification: Q51, Q54, E31