Banking on Nature | Operationalising Nature Risk in bank governance, credit risk processes and client business
Written by Sourajit Aiyer, Insight Contributor and author of the Banking on Nature series at In|Flow
As banks move from quantifying nature risks to structuring transactions in nature-oriented sectors, another key step is operationalisation. This aligns with the ‘greening of financial systems’ part of sustainable finance, but in the specific context of nature-related financial risks.
Operationalisation raises organisation-related questions for bankers. To link nature risk with capital allocation decisions, it needs to be embedded into organisational aspects like governance structures, risk appetite frameworks, credit policies and approval processes. The experience with climate risk has shown that only when risks are translated into internal processes, do they begin to influence financial flows.
Embedding Nature Risk into the Bank’s Risk Appetite Framework, Credit Policy and Client Business
The starting point for operationalisation lays in translating nature risk into the bank’s risk appetite framework (RAF). Risk appetite is a statement of how much risk the bank is willing to take in pursuit of its strategic objectives. For nature risk, this would require moving from qualitative to measurable commitments. A bank may define limits with concentration risk metrics, such as the percentage of loan book exposed to high water-stress regions, deforestation-linked supply chains, or biodiversity-sensitive regions. These limits can be informed by datasets such as ENCORE, WWF Risk Filter or IBAT. By doing so, nature risk is positioned alongside other risks within the RAF, rather than treated as a separate layer.
After risk appetite, the next step is to embed nature risk into credit policy. Credit policies typically define eligible sectors, underwriting standards, and conditions for lending for the bank. Nature risk can be incorporated by introducing sector-specific guidance. For example, enhanced due diligence requirements for agriculture, forestry, mining or infrastructure projects located in ecologically sensitive zones. Policies may require borrowers to demonstrate compliance with regulations related to deforestation-free supply chains or water usage. HSBC incorporated nature-related considerations into its agricultural and forestry sector policies, linking environmental risk assessment with credit approval processes. Such integration ensures that nature risk is assessed systematically at origination, rather than on a discretionary basis.
Following this, the integration of nature risk into credit approval and templates is where operationalisation becomes more tangible for banking functions like sales and credit. Credit memos and appraisal templates can be updated to include a section on nature risks, covering exposure, dependency and vulnerability. This may involve a checklist that identifies whether the borrower is exposed to high risk, and quantifies potential impacts on revenue and costs, etc. These assessments should feed into financial projections, leading to adjustments in ratios such as interest coverage ratio, debt service coverage ratio and leverage. This ensures that nature risk is used as an input in the financial analysis that drives credit decisions.
From internal rating models and pricing frameworks to sector limits and capital allocation decisions
Operationalisation could extend to internal rating models and pricing frameworks. While it is ideal to avoid creating nature risk scores that sit outside existing credit systems, it really depends on what their existent core banking software allows. In line with ESG risk factor integration approaches, quantified impacts of nature risk, such as reduced cash flows due to water scarcity or increased capex due to regulatory compliance, should be reflected in borrower financial projections and translated into rating adjustments within existing credit risk rating models. A deterioration may lead to a notch downgrade, which affects probability of default and pricing. This approach aligns with regulatory expectations on risk-based pricing and capital allocation.
At a portfolio level, nature risk should inform sector limits and capital allocation decisions and be linked to the Internal Capital Adequacy Assessment Process (ICAAP). If a significant portion of the loan portfolio is exposed to sectors or geographies vulnerable to ecosystem degradation, the bank may need to reassess capital buffers and concentration limits. For example, a high concentration of exposure to water-stressed regions may warrant tighter limits, higher risk weights, or increased provisioning buffers under stress scenarios. Exposures that enhance ecosystem resilience, say investments in water efficiency, regenerative agriculture or sustainable forestry, may be included in portfolio rebalancing strategies.
The Important Segregation of Risk Management Duties vs. Business Development
Governance plays a key role in ensuring these processes are consistently applied. Nature risk governance should be integrated into ESG and climate governance structures, rather than creating parallel processes. This ensures that environmental risks recognise the interlinkages between climate and nature. At the same time, clear delineation of roles is essential. The board and senior management are responsible for approving risk appetite statements and ensuring alignment with strategic objectives. The risk function is responsible for developing methodologies, defining thresholds, and monitoring exposures. The business and coverage teams are responsible for implementing frameworks in origination and client engagement.
Real World Case Studies of Shaping Governance and Credit Processes around Existing Policies
Examples from banks show how this integration is taking shape by adapting existing governance and credit processes. Triodos Bank has embedded biodiversity considerations into its lending policies and portfolio management, using ecological impact metrics to guide credit decisions and sector allocation. BNP Paribas has incorporated environmental and biodiversity considerations into its sector policies, particularly in agriculture and forestry, linking these to financing conditions and client engagement. Barclays, through its TNFD pilot, has translated nature-related insights into its credit policies for agriculture and forestry, and tightening restrictions on high-risk exposures. By embedding nature risk into existing templates, policies and models, banks can ensure that assessments are consistent, auditable and scalable.
Operationalising nature risk in bank governance and credit processes is a bridge between analysis and action. It requires translating ecological dependencies into measurable risk appetite parameters, embedding them into credit policies and workflows, integrating them into rating and pricing models, and aligning them with capital planning and governance structures.
The experience from climate risk integration shows that early movers are better positioned to manage risks and capture opportunities.
References:
BNP Paribas. (2023). Sector policies: Forestry, palm oil, agriculture and biodiversity. https://group.bnpparibas/en/financing-investment-policies
EIB. (2022). The EIB Group Climate Bank Roadmap 2021–2025: Supporting the European Green Deal. https://www.eib.org/en/publications/the-eib-group-climate-bank-roadmap
HSBC. (2022). Agricultural commodities and forestry sector policy. https://www.hsbc.com/-/files/hsbc/investors/hsbc-results/2022/annual/pdfs/hsbc-agricultural-commodities-and-forestry-sector-policy.pdf
IFC. (2021). Biodiversity finance: A guide for financial institutions. https://www.ifc.org/en/insights-reports/2021/biodiversity-finance
Taskforce on Nature-related Financial Disclosures. (2023). Recommendations of the Taskforce on Nature-related Financial Disclosures. https://tnfd.global/publication/recommendations-of-the-taskforce-on-nature-related-financial-disclosures/
Triodos Bank. (2020). Biodiversity in focus: A strategy for the financial sector. https://www.triodos.com/articles/biodiversity-in-focus
WWF. (2020). Nature is too big to fail: Biodiversity – the next frontier in financial risk management. https://wwfint.awsassets.panda.org/downloads/nature_is_too_big_to_fail_en_web.pdf
