Hidden harms: the economic and financial consequences of deforestation and its underlying drivers

Authors: Elena Almeida, David Lagoa and Thessa Vasudhevan

Deforestation and land-use change driven by environmentally-damaging extractive activities have far-reaching implications for economies and financial systems. This report furthers exploration of the role of deforestation as a driver of nature loss and source of potential economic and financial destabilisation, building on the work of the Network for Greening the Financial System (NGFS) and the International Network for Sustainable Financial Policy Insights, Research, and Exchange (INSPIRE) Study Group on Biodiversity Loss and Financial Stability.

Scope of the report

• The report examines the intricate connections between forest ecosystems and their economic and social dimensions by providing evidence on the links between forest loss and a host of economic and social factors such as impacts to health, productivity and livelihoods.
• By outlining potential transmission channels from deforestation and land-use change to economic and financial risks, the report aims to elucidate the complex mechanisms through which forest loss can destabilise the economy and financial system.
• The report also explores the reasons behind the continuation of deforestation, considering factors such as agricultural expansion, illegal logging and inadequate enforcement of environmental regulations. Grasping the economic pressures and governance amplifiers (governance systems that add to the economic risks from deforestation) that are facilitating deforestation is crucial for understanding future trends and developing effective strategies to mitigate deforestation and its associated risks.
• By contributing to the growing evidence base on the economic and financial ramifications of deforestation and land-use change, the report seeks to inform and influence policy decisions that will help safeguard forest ecosystems and ensure economic stability in the face of environmental challenges. The report thus outlines policy implications for financial supervisors, central banks and other economic policy actors, including:
  • Financial supervisors need to coordinate on enhancing microprudential frameworks through promoting and enforcing risk management processes that adequately account for nature-related risks, particularly deforestation-related risks.
  • Central banks can lead on the implementation of measures to mitigate deforestation risk, including by defining transition plans and actively monitoring and reporting on their portfolio exposure to deforestation risk, which is often underpriced by markets.
  • Economic policy actors can consider the negative impact of deforestation within their growth strategies, where large-scale forest destruction was previously commonplace. Cost–benefit analysis can demonstrate that such projects do not always have a clear economic case. Future economic policy decisions must explicitly account for the costs for forest loss, finding a balance between addressing economic pressure and ensuring the long-term sustainability of investments.