This press release originally appeared on Natural Capital Finance Alliance.
The agricultural sector is one of the sectors most exposed to environmental risk caused by climate change and human degradation of ecosystems.
A new template that enables financial institutions to conduct natural capital credit risk assessment across different agricultural sectors and geographies, taking into account factors such as water availability, use and quality; soil health; biodiversity; energy use and greenhouse gas emissions has been launched.
The new sector-specific guide is consistent with the leading international standard for including natural capital in business decision-making, the Natural Capital Protocol and complements the Natural Capital Finance Alliance’s new ENCORE tool and step-by-step guide to incorporating natural capital into bank’s risk management processes.
A healthy environment is the best foundation for economic prosperity, human health and well‐being. Yet environmental degradation continues in almost all areas of the world, ranging from serious to irreversible.
Food production already uses 50 per cent of the world’s total habitable land, and adequately feeding 10 billion people by 2050 will require a further 50 per cent increase in food production. Land degradation and desertification have increased, with land degradation affecting approximately 29 per cent of global land, where some 3.2 billion people reside.
Agriculture is therefore both fundamentally dependent on the environment, and a leading driver of environmental impacts. Farmers are key custodians of our soils, water and biodiversity, or what is now increasingly called our ‘natural capital’ – the natural resources and ecosystems that provide flows of environmental goods and services that underpin the global economy.
Banks that lend to this sector are therefore indirectly exposed to natural capital risk. Yet most still lend to farmers almost solely on the basis of their most recent profit and loss accounts.
New insight into natural capital’s link to production shows that while a farm’s financial performance can be improved over the short-term in an unsustainable way, for example by over-application of fertiliser, this can create medium-term risks, for example through a build-up of acidity in the soil, which can negatively affect the farmer’s financial performance, and therefore their ability to repay a loan. Degraded land and overuse of key inputs such as water will also reduce the asset value of farms over time.
Banks able to differentiate between a sustainably run farm and an unsustainably run farm could improve their own financial performance – because their loans would suffer less defaults on average – as well as drive improvements in the quality of the environment.
One challenge that was, up to now, holding banks back was that natural capital risks vary considerably across agricultural sectors and geographies. What is beneficial for one crop or type of livestock may be harmful for another. The new approach provides a global template for natural capital credit risk assessment which can be readily adapted for different agricultural sectors and geographies, taking into account factors such as water availability, use and quality; soil health; biodiversity; energy use and greenhouse gas emissions. The approach is designed to be consistent with the leading international standard for including natural capital in business decision-making, the Natural Capital Protocol.
The approach was developed by Dr Francisco Ascui (Senior Lecturer in Business and Climate Change at the University of Edinburgh Business School) and Theodor Cojoianu (Marie Curie and IRC Fellow at the University College Dublin, Michael Smurfit Graduate Business School) in response to growing demand for better frameworks to assess natural capital risks in key sectors of the economy.
Dr Francisco Ascui, Senior Lecturer in Business and Climate Change at the University of Edinburgh Business School said: "The agriculture sector is at the front line in terms of both its impacts and dependencies on the environment. Farmers are key custodians of our soil, water and biodiversity and depend on these resources for their livelihood, so lenders should recognise and reward more sustainable farming practices. This new approach to natural capital credit risk assessment is only a first step – the challenge will be in implementing it. This is a journey that we have to start, if we’re going to have any hope of achieving truly sustainable agriculture.”
Anders Nordheim, Programme leader for ecosystems and sustainable land use at UN Environment Finance Initiative said: “Agriculture and its future ability to provide a stable food supply in the face of accelerating environmental change is a concern for many financial institutions. Previous work in this area has provided anecdotal evidence of both asset and portfolio risk, but it is only now that we are able to construct robust frameworks and consistent information that enable analysis to support strategic decisions. This new approach is a key contribution.”