Is Credit Risk Affected By Environmental Degradation ?

Most people in the natural resource and environment or sustainable development sectors are aware of the linkages between environmental degradation, the unsustainable use of natural resources and economic costs.

However, it has been quite difficult to highlight the impact of the above on the costs of funding as well as the availability of credit. An exacerbating factor is the difficulty often encountered in ensuring that environmental risks are effectively considered in development and credit assessments.  Most businesses, banks and DFIs are beginning to pay more attention to environmental and sustainability issues. However, this often takes the form of mere lip service, green washing, or a basic compliance approach. In many cases the integration or mainstreaming of sustainability issues are left to the marketing department, and regarded as an add on or fringe department.

The impact of this has been a dilution of what was meant to be the mainstreaming of environment and sustainability considerations into business and the economy. This has also resulted in external risks to the financial and economic system being underestimated. One such risk is environment related credit risk, which has the potential to negatively impact multiple financial markets and have potentially significant economic and social impacts.

Some of the potential impacts and risks have been identified in the UNEP FI report titled; A New Angle on Sovereign Credit Risk. While focused on sovereign credit risk, the report raises issues that are not necessarily new or restricted to the sovereign credit risk sector. This is due to the fact that the findings of the report are based on bio-capacity and ecological footprint concepts that highlight some of the key development and economic related risks and issues.

Interesting points raised in the report are:

  • Natural resources, both renewable, such as biological resources (food and fiber), as well as nonrenewable resources (fossil fuels, ores and minerals) are critical to each nation’s economy.
  • To date, risks stemming from renewable resources in particular are not well-considered in sovereign credit risk assessments.
  • Traditional sovereign credit risk analysis appears to inadequately reflect pressures from increasing global natural resource scarcity, environmental degradation and vulnerability to climate change impacts
  • This report addresses how and why natural resource and environmental risks are becoming financially material for sovereign credit risk, not just in the medium term, but even in the short run.
  • A 10 per cent variation in commodity prices 0.2 and 0.5 per cent of a nation’s GDP. Given the recent fluctuations in commodity prices investors should take note of these issues in the short-term (0 – 5 years).
  • A 10 per cent reduction in the productive capacity of renewable, biological resources, and assuming that consumption levels remain the same, could lead to a reduction in trade balance equivalent to between 1 and over 4 per cent of a nation’s GDP. Given the growing body of scientific evidence on ecosystem degradation and climate change impacts, governments, bondholders and credit rating agencies should take note of these issues in the short to medium term.

Despite the implementation of sustainability reporting and compliance measures within organizations and the banking sector issues such as sovereign and credit risk seem to have been sidelined, diluted and or overlooked. The report is a great place to start the discussion on effective and integrated environmental risk assessment  and will hopefully encourage the type of planning and assessments measures at all levels and in all sectors which do in fact ensure sustainable development.

 Click here to read the report!