Embedding Water‑related Risks in Financial Stability Frameworks

There is now growing recognition among financial authorities that climate and broader nature-related risks need to be better understood (NGFS, 2022[4]). Water-related risks are a key component of this; the implications of hydrological shocks are wide-ranging. Water scarcity and drought can disrupt production, reduce agricultural output, and amplify supply chain fragilities. Floods and contamination events can damage assets, interrupt business operations, and erode asset values. These disruptions can impact financial institutions by generating credit losses, reducing liquidity, and increasing market volatility. At sufficient scale, these effects can accumulate and become systemic, particularly when multiple shocks coincide or affect water-dependent or exposed economic hubs (Davies and Martini, 2023[5]; DNB, 2021[6]).

Central banks and financial supervisors are taking important steps to incorporate climate risks into macroprudential supervision, especially through the development of scenario analysis and stress testing (NGFS, 2020[7]). However, the integration of nature-related risks, including freshwater degradation, remains at an early stage (IMF, 2024[8]). A limited number of jurisdictions have begun to develop supervisory frameworks and methodological tools for understanding and managing water-related financial risks. While existing initiatives such as the conceptual framework defined by the Network for Greening the Financial System (NGFS) and the OECD’s supervisory guidance on nature-related financial risks provide a foundation, they often treat freshwater risks as one element among many, without fully addressing their distinctive characteristics or systemic implications (OECD, 2023[9]; NGFS, 2024[10]).

Early analysis of the impacts of nature-related economic and financial risks shows significant results, and these estimates all highlight the critical role of water. The approaches used in these estimates are still in fairly early stages and likely to be conservative given the difficulty of modelling complex interaction between ecosystem services, as well as the interaction of ecosystem services with the economy (Gardes-Landolfini et al., 2024[11]). Nevertheless, the value of water-related economic risks is estimated to be equivalent to 7 to 9% of Global Gross Domestic Product (GDP), highest amongst other ecosystem services (Ranger et al., 2023[12]).

Doing nothing until perfect information is available is not an option: failing to account for nature risks leads to mispricing and misallocation of capital, thereby increasing the likelihood of abrupt losses down the line (MNB, 2023[13]). Thus, regulators and researchers are proceeding with best-available methods, while acknowledging these limitations. Each pilot and framework provide lessons that will refine future models (for example, improving how to link drought scenarios to a specific company’s financials, or how to aggregate firm-level impacts into system-wide stress). There is an important role for judgment and expertise in identifying water-related economic and finance risks. Collaboration, across financial authorities with academia and environmental agencies possessing technical expertise, is essential for effective risk assessment and management.

Moreover, addressing resilience will require action on many fronts. Financial authorities must play a leading role by embedding water risks into core supervisory frameworks and monetary operations, where appropriate. Policymakers must ensure that real economy regulations support sustainable water use and long-term economic resilience. Financial regulators have a crucial role to play in developing enabling regulations and market standards, such as taxonomies and disclosure requirements, that provide coherent rules across financial markets and facilitate access to transparent, comparable data. All must work together to develop common definitions, shared datasets, and coherent strategies. Only through such coordinated action can financial systems remain robust in a future shaped by intensifying hydrological stress.

This report aims to support these efforts by equipping financial authorities with practical guidance, tools, and frameworks for integrating water-related risks into financial supervision. It highlights the uniqueness of water-related risks, the ways these transmit to financial systems, and the limitations of current models and data.

• Elevate water-related risks in financial stability agendas: Recognise water-related risks as material to financial and price stability and champion their inclusion in international fora (G20, Financial Stability Board, NGFS). Central banks can leverage their analytical capacity and system-wide perspective to drive investment and reform towards water resilience.

• Integrate water risk into supervision and regulation: Strengthen prudential frameworks by explicitly requiring the identification, assessment, management, and disclosure of water-related risks. Supervisors should issue targeted guidance for financial institutions to embed these risks in risk management processes and scenario analysis.

• Enhance data, tools, and capacity: Invest in improved data, expand analytical tools, and develop capacity to assess nature- and water-related risks, in partnership with environmental agencies, academia, and international bodies. Address data and modelling gaps through collaborative pilot projects and knowledge exchanges.

• Align finance with polices that support water security and the protection of nature: Coordinate across sectors to align financial flows with policies that ensure sustainable water use and drive ecosystem protection, supporting both SDG 6 and financial stability objectives.

• Strengthen enabling frameworks: Integrate water-related risks into disclosure standards, taxonomies, and due diligence. Promote coherence and traceability in market-based and supervisory instruments, ensuring capital is steered towards resilient and sustainable activities.

[5] Davies, L. and M. Martini (2023), “Watered down? Investigating the financial materiality of water-related risks”, OECD Environment Working Papers, No. 224, OECD Publishing, Paris, https://doi.org/10.1787/c0f4d47d-en (accessed on 25 September 2024).

[6] DNB (2021), Flood risk and financial stability: Evidence from a stress test for the Netherlands, https://www.dnb.nl/media/st5psfvb/working_paper_no-_730.pdf (accessed on 29 August 2024).

[11] Gardes-Landolfini, C. et al. (2024), “Embedded in Nature: Nature-Related Economic and Financial Risks and Policy Considerations”, Staff Climate Notes, Vol. 2024/002, p. 1, https://doi.org/10.5089/9798400288548.066.

[3] Global Commission on the Economics of Water (2024), The Economics of Water: Valuing the Hydrological Cycle as a Global Common Good, Global Commission on the Economics of Water, https://watercommission.org/publications/ (accessed on 28 February 2025).

[8] IMF (2024), Embedded in Nature: Nature- Related Economic and Financial Risks and Policy Considerations, https://www.elibrary.imf.org/view/journals/066/2024/002/article-A001-en.xml (accessed on 18 October 2024).

[13] MNB (2023), MNB Green Programme: results of the Biodiversity project to date have been presented. Press Release, Hungarian Central Bank (Magyar Nemzeti Bank "MNB"), https://www.mnb.hu/en/pressroom/press-releases/press-releases-2023/mnb-green-programme-results-of-the-biodiversity-project-to-date-have-been-presented (accessed on 2 April 2025).

[10] NGFS (2024), Nature-related Financial Risks: a Conceptual Framework to guide Action by Central Banks and Supervisors [Final version], https://www.ngfs.net/sites/default/files/medias/documents/ngfs-conceptual-framework-nature-risks.pdf (accessed on 19 August 2024).

[4] NGFS (2022), NGFS acknowledges that nature-related risks could have significant macroeconomic and financial implications | Banque de France, Network for Greening the Financial Sphere Press release, https://www.ngfs.net/en/communique-de-presse/ngfs-acknowledges-nature-related-risks-could-have-significant-macroeconomic-and-financial (accessed on 9 January 2023).

[7] NGFS (2020), Guide to climate scenario analysis for central banks and supervisors, Network for Greening the Financial System, https://www.ngfs.net/en/publications-and-statistics/publications/guide-climate-scenario-analysis-central-banks-and-supervisors (accessed on 5 February 2025).

[9] OECD (2023), A supervisory framework for assessing nature-related financial risks, OECD Business and Finance Policy Papers, No. 33, OECD Publishing, https://doi.org/10.1787/a8e4991f-en.

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[12] Ranger, N. et al. (2023), “The Green Scorpion: the Macro-Criticality of Nature for Finance – Foundations for scenario-based analysis of complex and cascading physical nature-related risks”, Oxford: Environmental Change Institute, University of Oxford, https://www.ngfs.net/en/the-green-scorpion-macro-criticality-nature-for-finance.

[2] Richardson, K. et al. (2023), “Earth beyond six of nine planetary boundaries”, Science Advances, Vol. 9/37, https://doi.org/10.1126/sciadv.adh2458.