LENDING an Approach Based on the Natural Capital Protocol
Agriculture is a high risk sector both in terms of its dependencies and impacts on natural capital. A confluence of pressures driven by consumption patterns and demographic changes, land degradation, water scarcity, pollution, loss of biodiversity and climate change combine to compromise our ability to continue current production patterns while satisfying increasing demand from population growth and changing diets. We are seeing increasing incidents of droughts, floods, pollination failure and changing temperature patterns affecting yields and crop selection. Despite this, the finance sector has relatively little experience with assessing agricultural sustainability and its effect on longterm productivity in a systematic manner. Supporting financial institutions’ ability to analyse natural capital related risks and opportunities in agriculture requires the development of new decision support frameworks for different asset classes and financial products. Here we provide a framework for the inclusion of natural capital considerations into credit risk assessment for agricultural lending. The framework is presented as a more detailed elaboration of the overarching framework for identifying, measuring and valuing natural capital impacts and dependencies set out in the Natural Capital Protocol (Natural Capital Coalition 2016) and the Connecting Finance and Natural Capital supplement to the Protocol (Natural Capital Coalition 2018). The work follows from the launch of the Natural Capital Finance Alliance’s ENCORE (Exploring Natural Capital Risks, Opportunities and Exposure) tool in 2018, which systematically details the dependency link between nature and economy, developed in partnership with UNEP-WCMC. The first application of the ENCORE environmental risk framework, Integrating natural capital in risk assessments: A step-by-step guide for banks, was published in 2019 in partnership with PwC. This details an overarching approach to advanced environmental risk management by banks, with case studies covering mining, agriculture and infrastructure. This report builds on previous work by presenting an in-depth approach to natural capital and credit risk in agriculture. This framework has been developed on the knowledge that agricultural enterprises have significant impacts and dependencies on natural capital, leading to risks (and opportunities) which are unlikely to have been fully evaluated by lenders in the past, leading to sub-optimal allocation of capital in current credit risk assessment processes. Evaluating these natural capital risks (and/or opportunities) would allow improved allocation of capital, with more flowing towards enterprises with better management of natural capital impacts and dependencies, resulting in enhanced financial outcomes for the lender, and greater value for society as a whole. A process for natural capital assessment is incorporated in a generic model for credit risk assessment, which proposes that the overall risk is a product of the current risk level, the likely future trend over the relevant timescale(s), the probability of the risk being priced and the farmer’s ability to mitigate the risk. The model is applied to wheat production in Australia, but can be adapted to other agricultural production systems in different regions. This work is one of a growing number of examples of approaching natural capital risks and opportunities in the finance sector from a pricing perspective, which are available on the Natural Capital Finance Alliance website.