The changing nature of financial risk in Malaysia

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A Malayan Tiger at the Endau-Rompin National Park, Malaysia A Malayan Tiger at the Endau-Rompin National Park, Malaysia

Home to tigers, orangutans, elephants, and tapirs, along with 742 species of birds and an estimated 15,000 species of vascular plants, Malaysia is ranked 12th in the world according to the National Biodiversity Index. Given its status as one of the few nations classified as “megadiverse,” many economic activities in Malaysia are directly or indirectly dependent on nature and its associated ecosystem services.  

NATURE LOSS AND ECONOMIC AND FINANCIAL LOSS

Yet, nature is declining faster than at any period in human history, triggered by human activities, which can lead to detrimental economic impacts and incalculable losses to well-being. A recent World Bank study found that Malaysia could experience a 6 percent gross domestic product (GDP) annual loss by 2030 compared to a baseline scenario in a scenario of partial ecosystem collapse. Economic impacts could transmit to the financial sector, and vice-versa.  Similarly, banks, through lending to economic activities, are affected by what happens in nature and can impact nature through their lending (Figure 1).

Figure 1: Share of self-employment (own account and entrepreneurship) among employed working-age population (males aged 20-55)
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Figure 1: Share of self-employment (own account and entrepreneurship) among employed working-age population (males aged 20-55)

The World Bank and Malaysia’s Central Bank, Bank Negara Malaysia (BNM) collaborated to produce in 2022 An Exploration of Nature-Related Financial Risks, an analysis that was the first of its kind in Asia. Three countries, Netherlands, France, and Brazil, had published the results of their study of nature-related financial risks before Malaysia, and the Malaysian study was recently presented at COP27’s Biodiversity Day in Sharm el-Sheikh. The Malaysian study uses domestic and global data to assess nature-related financial risks for Malaysian banks and provides a roadmap for key stakeholders to help mitigate those risks. 

Unsurprisingly for a country with its wealth of natural assets, Malaysian banks are highly exposed to a broad range of nature-related physical and transition risks. As shown in Figure 2, Malaysian banks are highly dependent on nature exposing them to physical risks from nature loss. Lending exposures were especially high to sectors that depend on surface water, climate regulation, and flood and storm protection as their primary source of ecosystem service. Most commercial lending from Malaysian banks (87 percent) highly impacts nature via greenhouse gas emissions and extensive water and terrestrial ecosystem use. This lending could be affected by future changes in policy, technology, and consumer preferences responding to nature loss, thus representing transition risks.  
 

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Dependencies and impacts of the Malaysian banking system on nature.

FROM IDENTIFICATION TO ACTION

With a greater understanding of how nature-related financial risks manifest in Malaysia, BNM and other key stakeholders can take action to address these risks. BNM, is now better positioned to analyze and consider how to mitigate these risks within its scope of mandate, leveraging progress made on climate risks to address broader nature-related risks. This was also emphasized by BNM Governor Tan Sri Nor Shamsiah Yunus at the launch of the nature-related risk report: “While the primary responsibility for addressing these priorities rests with the government, the financial industry and authorities have a critical interest in deepening our understanding and appreciation of the interactions between climate- and nature-related risks.”  

Like climate change, addressing the nature-related agenda demands a multi-stakeholder approach. Possible actions that BNM could consider range from public awareness raising, capacity building and risk identification, to the development of regulatory and supervisory expectations (Figure 3). Most actions would need to be jointly conducted with other stakeholders such as ministries of finance, ministries responsible for environmental issues, state-level agencies, and financial institutions. The intensity of the actions differs, recognizing the need for prioritization in this challenging post-pandemic and high-inflationary period. Moreover, BNM is contributing towards knowledge development and regulatory discourse on nature-related financial risks, bringing the valuable perspective of a megadiverse developing country to global fora such as COP27. Furthermore, both Malaysia and the World Bank are active participants in the Network for Greening the Financial System (NGFS), where a new task force will support the management of nature-related risks. 

COP15 (15th Conference of Parties to the UN Convention on Biological Diversity) begins in Montreal this week, and there the World Bank and other partners can continue to support the global nature finance agenda underpinning sustainable development. It could support Malaysia in continuing to build a resilient financial sector that can support its goals of achieving advanced economy status, for example in developing innovative instruments to finance nature-positive investments. At the same time, the World Bank will leverage this experience collaborating with Malaysia to support other countries facing similar development challenges to achieve a more sustainable and inclusive future.  
 

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Possible actions to address challenges of nature-related financial risks.

Authors

Rekha Reddy

Senior Financial Sector Specialist

Nepomuk Dunz

Financial Sector Economist

Henk Jan Reinders

Financial Sector Economist

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