Embedding Water‑related Risks in Financial Stability Frameworks

6. Policy recommendations

Abstract

Embedding water risks within macro and microprudential frameworks can enable financial authorities to better anticipate and manage severe shocks to financial systems. However, effective management requires cross-sector collaboration, as policymakers must address activities impacting freshwater systems. A robust investment and regulatory framework is also essential to align finance with sustainable water use and mitigate systemic risks. This chapter formulates policy recommendations for central banks and financial supervisors, as well as for policymakers, academia and private sector to jointly address water-related financial risks.

Summary of key recommendations

Elevate water-related risks in financial stability agendas: recognise water-related financial risks as material to financial and price stability, and champion this discussion in international economic and financial fora (e.g. G20, FSB, NGFS)​. Central banks’ analytical capacity and system-wide view mean they can contribute to improving system resilience by elevating issues within government agendas, enabling policymakers to prioritise structural reforms and investment in water resilience.

Integrate water-related risk into supervision and regulation: strengthen central bank and supervisory frameworks to explicitly integrate water-related risk management and disclosure. Regulators should issue guidance for financial institutions to assess, report, and mitigate water-related risks within existing prudential risk management processes​.

Enhance data, tools, and capacity building: invest in vastly improving data availability, analytical tools, and develop institutional capacity to assess nature-related risks (including water), acknowledging current data gaps and modelling challenges (FSB, 2024[1])​. Collaboration is central to this process. Regulators, academia, financial institutions, and international bodies (NGFS, UNEP FI, etc.) have complementary skills, expertise and mandates to strengthen tools and approaches and build technical capacity across financial systems.

Align finance with water policies and ecosystem protection: promote policies that align financial decision-making with sustainable water management through cross-sectoral policies. Policies across sectors (economic development, agriculture, industry, tourism, etc..) have a critical role to play in terms of protecting freshwater ecosystems and reducing water-related risk, in line with SDG 6 targets on water security. This ensures financial stability objectives are pursued hand-in-hand with environmental sustainability goals.

Strengthen enabling frameworks: ensuring that supervisory and market-based instruments are supported by credible data from disclosure, taxonomies, and due diligence. Countries can champion the robust integration of water-related risks and opportunities into these frameworks so that they that explicitly cover water-related risks and impacts. An enabling policy environment also helps redirect capital flows toward activities that reduce water-related risks and increase systemic resilience.

6.1. Anchoring water in financial stability mandates

6.1.1. Recognising water as a systemic financial risk and elevating its importance in financial stability agendas

Elevating water-related risks on national and international agendas

Scarcity, floods, pollution, and ecosystem degradation, pose material threats to economic activity and price stability, as discussed in Chapter 3. Central banks can play a critical role in signalling when environmental degradation escalates into a systemic financial risk. Central banks’ analytical capacity and system-wide view mean they can contribute to improving system resilience by elevating issues within government agendas, enabling policymakers to prioritise structural reforms and investment in water resilience. This signalling function is especially important where risks may be accumulating invisibly, and where proactive public policy responses are needed to mitigate cascading impacts across the economy and financial system.

Global coordination is also critical. There is a need to champion water-related risk at international level. Policymakers should use platforms like the G20, the Financial Stability Board (FSB), and United Nations fora to mainstream the topic of water-related financial risks. Recent developments signal momentum: the G20 Sustainable Finance Working Group in 2023 added nature and biodiversity-related risks (which encompass water-related risks) to its agenda. Building on this, finance ministers, central bank governors, and regulators should ensure that discussions on climate risk are broadened to include water security and ecosystem considerations. Elevating water-related risks in these fora will foster global recognition and coordinated action, similar to the way in which climate-related financial risks have been acknowledged over the past decade. This means building on existing and ongoing work, including the work of the FSB, NGFS, the OECD, the IMF, national financial supervisory authorities or academia and many others to assess broader environmental risks to stability.

By treating water security as a financial stability issue, policymakers also reinforce global initiatives like the UN 2023 Water Conference’s Water Action Agenda, which highlighted the need to involve the financial sector in water resilience commitments (OECD, 2023[2]).

Strengthening analysis of the macro-economic implications of water

While there is ample evidence of the macro-economic impact of climate and nature related water-related risk, water remains under-recognised in macroeconomic policy and financial supervision. These risks are often local in origin, with less understanding of national or international consequences, and how risks may cascade across supply chains, credit markets, inflation, and fiscal stability. To close this gap, central banks and financial authorities must elevate water-related risks as macro-critical, embedding them more systematically into monetary and macroprudential agendas. This requires strengthening the analytical foundations that link water to key macroeconomic indicators and financial stability objectives.

This also means improving how water-related shocks, such as droughts, floods, and pollution events, are incorporated into macroeconomic models and monetary policy assessments. Currently, most macroeconomic frameworks overlook hydrological constraints or treat water as an unlimited input, leaving blind spots in projections for growth, inflation, and productivity. Yet, water-related risks can have widespread second-order effects, disrupting supply chains, driving up food and energy prices, depressing labour productivity, and shifting trade balances. Localised water stress can also have asymmetric national effects, especially when it impacts critical sectors or regions, influencing credit conditions, inflation expectations, and capital flows. A more nuanced understanding of these dynamics would enable central banks to better assess vulnerabilities, calibrate monetary and macroprudential responses, and inform fiscal coordination. Cross-disciplinary collaboration is needed to develop robust tools, improve data infrastructure, and align hydrological risk metrics with macro-financial indicators.

6.1.2. Integrating water into supervisory frameworks

Financial supervisors and central banks should embed water-related risk management into regulatory and supervisory frameworks. This means updating guidance, expectations, and prudential tools so that banks, insurers, and investors identify, manage, and disclose water-related financial risks as part of routine supervision.

Despite growing awareness, regulatory and supervisory treatment of nature- and water-related risks remains nascent and inconsistent across jurisdictions (FSB, 2024[1]). Traditionally, environmental risks (beyond climate) have been treated only qualitatively or as a subset of broader risk drivers. To ensure financial system resilience, supervisors need to close this gap. Strengthening supervisory frameworks will push financial institutions to proactively manage water-related risks, for example, by assessing loan portfolio exposure to drought-prone regions or the impact of flood risk on insurance underwriting. By incorporating water-related factors into stress testing, scenario analysis, and prudential reporting, supervisors can better gauge systemic vulnerabilities. The ECB and others have already begun encouraging banks to include environmental factors (such as freshwater scarcity, pollution, biodiversity loss) in risk management, but more specific guidance on water is needed (ECB, 2020[3]).

Central banks and prudential authorities should develop clear expectations for managing water-related risks. Building on emerging best practices, they can update existing climate risk guidance to explicitly cover water. For example, the Hong Kong Monetary Authority’s guidance asks banks to assess not only climate risks but also environmental risks such as water pollution and water scarcity in their risk management processes (HKMA, 2021[4]). Such approaches should be expanded and adopted globally. In the short term, supervisors can require financial institutions to evaluate their exposures, dependencies, and impacts related to water (e.g. reliance on water-intensive borrowers or infrastructure at risk of flooding) as part of routine risk assessments. They should also encourage firms to include water-related risk in existing disclosure regimes (such as climate risk reports or broader ESG disclosures). Over the medium term, regulators might incorporate water-related risk metrics into prudential reporting (for instance, adding water stress indicators into credit risk assessments) and conduct thematic reviews of how institutions are managing these risks. Ultimately, the goal is to have water-related risks integrated into the core supervisory framework, akin to stress tests or capital adequacy evaluations for other major risk factors.

To strengthen the management of water-related financial risks, supervisors can deploy a range of tools within existing regulatory frameworks. For example, requirements under Pillars 2 and 3 of the Basel framework can be expanded to ensure that financial institutions systematically assess and disclose their water dependencies, exposures, and impacts. This may include issuing strengthened guidance on scenario analysis for highly exposed sectors, such as agriculture, textiles, or energy. Supervisors can also integrate water-related risk indicators into prudential reporting and credit risk assessments to ensure that these risks are reflected in day-to-day financial decision-making. In addition, conducting thematic reviews of financial institutions’ water-related risk governance and risk management practices can help identify gaps and promote good practices across the sector. Monitoring how water-related vulnerabilities are captured in capital planning processes and stress test outcomes further enables supervisory authorities to assess whether financial institutions are adequately prepared for water-related shocks.

Emerging best practices offer useful models. For example, the ECB and HKMA are encouraging banks to integrate water stress and pollution into broader environmental risk management frameworks. Regulators worldwide should build on these approaches, issuing guidance and supervisory expectations that place water-related risks on par with climate risks.

Leading by example

Central banks can also leverage their soft power, particularly as large institutional investors, by managing water-related financial risks within their own portfolios. Like the DNB, who assessed impacts and dependencies of own portfolios on nature in a pilot study (Box 4.4), central banks can apply frameworks such as TNFD to evaluate sovereign and central bank exposure to water stress. In line with risk findings and with sustainable finance objectives, central banks could adjust their own investments to reflect water-related financial risks. These steps not only enhance balance sheet resilience but also demonstrate leadership, helping build capacity on undertaking these risks assessments and mainstreaming water-related risk management across the financial sector.

6.1.3. Building data, tools, and capacity for financial stability assessments

Central banks, financial authorities, academia, regulators, private sector, and international organisations need to work together to prioritise expanding data collection, developing analytical tools, and building capacity to assess water-related and other nature-related financial risks. Given the novelty and complexity of these risks, a concerted effort across areas of expertise is needed to improve the information and tools available for assessing water-related risks to the financial system.

Effective risk management is hampered today by significant data and modelling gaps in the nature and water-related risk domain. As noted by the FSB, authorities embarking on this work face “major data and modelling challenges”, with a lack of reliable, consistent data on financial institutions’ exposures to nature-related risks (FSB, 2024[1]). For example, banks may not have granular data on clients’ water usage or local water stress indices, and insurers may lack long historical records for extreme hydrological events under climate change. Similarly, translating ecological data (like river basin water levels or groundwater depletion rates) into financial risk metrics is an evolving science. The paucity of data and methodologies makes it difficult for supervisors and firms to quantify potential losses or price in water-related risk. Furthermore, expertise is limited, many institutions do not have hydrologists or environmental scientists working alongside risk analysts. There is general recognition that more expertise is needed in the supervisory community, in central banks, and in the private sector to understand and address nature-related risks, and numerous capacity-building initiatives are only just getting underway. Without better data and stronger analytical capacity, water-related risks could remain hidden until they translate into crises.

Moving the needle on the analysis

Unaddressed water-related risks could escalate systemic vulnerabilities and disrupt financial stability. There is a need for greater scenario analysis integrating water-related physical risks into macro-financial models, enabling forward-looking assessments of how water shocks and long-term degradation of freshwater ecosystems could affect inflation, growth, and financial stability. Long-term, the aim is to have a robust global information architecture for nature-related financial risk, like what already exists for credit or market risks, supported by a community of practitioners with the requisite expertise.

To address these challenges, financial authorities should consider a number of priority actions to strengthen financial stability assessment. This requires:

• Building on existing climate stress testing frameworks to systematically incorporate water-related risks in these assessments, both in terms of acute shocks (e.g. floods, droughts) and chronic stressors (e.g. declining water availability, pollution, and ecosystem degradation).

• Furthering the development of scenario methodologies to reflect the full spectrum of water-related financial risks, including freshwater ecosystem degradation. This means implementing NGFS recommendations to integrate nature-related risks into scenario analysis and stress test methodologies, while also recognising the limitations of current climate-focused models and expanding the scope to include a broader set of ecological drivers.

• Given the diversity of approaches among central banks and supervisors, there is also value in moving toward standardised methodologies and guidance for assessing water-related risks. Harmonisation across jurisdictions would support the comparability of risk assessments and promote the development of shared best practices in macro-financial supervision.

• Further exploring cross-sectoral scenario analysis to evaluate the systemic effects of water-related risks on interconnected industries, particularly those with high dependency on freshwater resources, such as agriculture, hydropower, and manufacturing. These exercises should be grounded in region-specific hydrological and ecosystem data, developed in collaboration with water authorities and basin-level agencies. Incorporating local and national water stress projections into macroprudential tools will allow for more accurate estimation of financial system exposures to water scarcity and pollution.

• Developing specific indicators for water-related financial stability risks. These may include metrics tracking exposure concentrations in water-stressed geographies, sectoral lending to water-dependent industries, and the resilience of financial institutions to hydrological hazards. Embedding such indicators into systemic risk monitoring would help supervisors detect emerging vulnerabilities before they materialise into broader disruptions.

Collaboration is key

Aligning incentives among diverse actors (regulators, private sector, academia, and water authorities) can be complex and slow-moving. Coordination is necessary to facilitate data and method-sharing, with next steps focusing on advocating for greater focus of water-related risks within financial frameworks. Collaboration should also extend across the private sector, academia, and policymakers, with a push to recognise and price water-related risks appropriately in financial decision-making. However, it is important to recognise that effective coordination faces significant challenges, including legal, privacy, and proprietary constraints on data sharing across jurisdictions, as well as the difficulty of aligning incentives among diverse stakeholders. To address these challenges, establishing clear governance frameworks and incentive mechanisms will be essential to foster trust and facilitate meaningful collaboration.

Actions to support coordination should include:

• Collaboration between central banks and international bodies, for example through joint task forces to identify critical data needs and indicators for water-related risk (e.g. determining sector-specific metrics for water-related impacts).

• The development of more open-source databases and tools, for instance, expanding platforms like the NGFS climate scenarios to include water stress scenarios, or leveraging satellite data for water-related risk monitoring.

• Collaboration with water authorities and basin-level agencies to ensure that water-related scenarios are grounded in scientific and region-specific hydrological data.

• Collaboration with academia, international organisations, academic researchers and private sector to develop and strengthen analysis (for example, linking ecosystem health to sovereign credit risk), or convene financial institutions for pilot projects.

• Capacity building should be intensified via knowledge-sharing workshops, training programs, and technical assistance. Non-governmental organisation and industry groups have already begun providing training on water-related risk management for banks and this should be scaled up.

By investing in shared tools and building the technical community to apply them, the financial system will be better equipped to identify risks early, assess impacts robustly, and strengthen systemic resilience.

6.2.  Beyond supervision: policy levers for systemic water resilience

Water is at the heart of climate change and nature degradation and is a foundational element of climate resilience, food security, economic productivity, and financial stability. As climate change intensifies and freshwater ecosystems degrade, the materiality of water-related risks to economic development, infrastructure investment, and financial systems becomes increasingly evident. Ensuring that water security and financial stability are mutually reinforcing demands a more coherent and integrated approach to policy, regulation, and governance.

6.2.1. Aligning financial policy with water and environmental policies

Financial regulators, environmental authorities, and water management agencies must work together so that efforts to maintain financial stability and to ensure water security are mutually reinforcing. Water-related financial risks are deeply shaped by decisions in the real economy, including how water is governed, priced, allocated, and protected. These cannot be managed by the financial sector alone. They are fundamentally intertwined with economic, environmental and water governance decisions: physical water-related risks are driven by how to manage water resources, land use, climate change, and ecosystems. For example, inadequate water governance (such as lack of investment in reservoirs or poor enforcement of pollution controls) can increase drought and contamination risks, which in turn translate into greater financial losses. Conversely, strong water management and ecosystem protection can mitigate these risks at their source, thereby reducing the burden on financial institutions and insurers. It is therefore crucial to align incentives and actions across sectors.

Key priorities include:

• Improving policy coordination between government (e.g. environmental ministries / agencies) and the financial authorities and regulators. Establishing and strengthening institutional coordination mechanisms between finance and environmental authorities, as well as with public and private stakeholders could significantly improve policy implementation. These could take the form of working groups, dialogues and consultation mechanisms, or shared data and information platforms.

• Integrating water resilience into public investment planning, ensuring that infrastructure and fiscal stimulus packages promote water efficiency, disaster risk reduction, and long-term resilience. Infrastructure built today will shape risk exposure for decades to come (OECD, 2022[5]).

• Strengthening national water policies, to improve water governance, allocation, and resource management, ensuring financial stability through sustainable water infrastructure, in line with OECD Council Recommendation on Water (OECD, 2016[6]).

• Promoting sustainable industrial and urban policy, through water-efficient building codes, pollution control regulation, and land-use planning that reduces exposure to floods and droughts in key economic zones.

• Supporting freshwater ecosystem protection, as healthy ecosystems are critical buffers against hydrological risk, and underpin the sustainability of sectors like agriculture, energy, and tourism.

6.2.2. Strengthening the financial regulatory ecosystem

Prudential regulation operates within a broader financial regulatory landscape that must evolve to capture nature-related financial risks, including water. This includes aligning market regulations, corporate disclosure frameworks and investment classification systems with environmental objectives.

To support water security and water-related financial stability objectives, policymakers can:

• Ensure that robust water criteria are integrated into sustainable finance taxonomies, so that water efficiency, pollution control, and ecosystem protection are central to sustainable finance,

• Strengthen corporate disclosure requirements on water usage, basin-level dependencies, and transition plans, building on frameworks such as CSRD, ESRS (E3), and ISSB’s IFRS S2. These disclosures provide critical data for financial institutions and supervisors.

• Mandate due diligence frameworks that address water-related risks in global value chains, especially in sectors such as agriculture, apparel, and mining. The EU’s Corporate Sustainability Due Diligence Directive (CSDDD) is an important step in this direction.

• Ensure coherence across jurisdictions, minimising fragmentation and supporting interoperability between different standards. Harmonised approaches help global financial institutions assess risk consistently and reduce uncertainty.

• Align prudential, sustainability, and environmental regulation, so that risk-informed capital allocation is supported by shared definitions, metrics, and incentives.

6.2.3. Enabling risk-informed capital allocation

An enabling policy environment helps redirect capital flows toward activities that reduce water-related risks and increase systemic resilience. This includes:

• Ensuring that supervisory and market-based instruments are supported by credible data from disclosures, taxonomies, and due diligence.

• Encouraging financial institutions to consider water resilience as a factor in credit risk assessments, investment decisions, and product design.

• Rewarding proactive corporate behaviour on water management through preferential treatment in financial regulation or public finance (e.g. green bonds, subsidies, or guarantees linked to water-positive activities).

By embedding water into the enabling frameworks that govern financial decision-making, governments can help ensure that water-related risks are not just disclosed but actively reduced.

Conclusion

Water is not only an environmental concern: it is a key foundation of economic value and financial system resilience. Ignoring water-related risks leaves the financial system exposed to structural vulnerabilities that will only grow over time if not adequately managed. But with timely action, coordination, and innovation, central banks, supervisors, and policymakers can focus on building resilience when it comes to water, rather than see it purely as a source of risk. The next UN Water Conference that will take place in 2026 provides a critical moment to raise ambition, align efforts, and forge a global coalition committed to integrating water into financial stability agendas.

To help policymakers effectively sequence and prioritise actions, Table 6.1 sets out short-, medium-, and long-term recommendations for embedding water-related risks in prudential regulation and financial policy. Short-term actions focus on raising awareness, producing and applying robust guidelines, and initiating policy coordination. Medium-term actions point towards deepening integration into supervisory and financial frameworks, while long-term actions focus on global alignment and deep structural reforms to manage water-related financial risks in a systemic manner.

Table 6.1. Actions in the short, medium and long term

Timeline	Recommendation	Concrete Actions	Key Actors	Indicative Milestones
Short-term	Elevate water-related risk in financial stability agendas	- Explicitly recognise water-related risks in central bank and supervisor communications - Put topic on G20, FSB, and NGFS agendas - Assign responsibility for water risk awareness and reporting in financial authorities	Lead: Central banks, supervisors Support: Ministries, international bodies, IGO	- Inclusion in 2 to 3 central bank Financial Stability Reports - Water-related risks discussed in G20 communique or NGFS agenda
	Strengthen policy coordination	- Establish joint committees/task forces among finance, environment, water agencies - Initiate cross-sector workshops and data-sharing platforms - Set up regular inter-agency dialogue	Lead: Ministries of finance and environment Support: Central banks, regulators	- Inter-agency MoU or task force launched - 2 to 3 joint outputs or workshops held annually
	Enhance data, tools, and capacity	- Map current exposures using available data, ensuring coverage of both green and blue water-related risks - Launch pilot projects on water-related risk (e.g. scenario exercises), aligned with emerging science on hydrological systems and water accounting - Start targeted capacity-building and staff training - Build awareness of the importance of green water in agriculture, ecosystems, and water-related dependencies	Lead: Supervisory authorities Support: Private sector, academia, IGO and NGO	- Pilot water-related risk scenario analysis published - Supervisory staff training completed - Both green and blue water risks explicitly covered in data mapping or guidance materials
	Initial steps in supervision & disclosure	- Issue supervisory statements/guidance on water risk inclusion - Rapid inclusion of environmental risk indicators in annual supervisory priorities - Ensure that climate and environmental disclosures to include water metrics	Lead: Supervisors, standard setters Support: regulators	- Water risks included in 1 to 2 supervisory statements -Water metrics referenced in reporting standards
Medium-term	Integrate water-related risk into supervision	- Systematically embed water risk into prudential frameworks (capital, risk, and scenario analysis)	Lead: Central banks, financial supervisors Support: academia, IGO, NGO	-Water risk modules integrated in at least one Supervisory review cycle - Scenario tools used in Supervisory processes
	Advance harmonisation of disclosure and data standards for water	- Align reporting/disclosure frameworks for water (e.g. with EU taxonomies, CSRD, ISSB)	Lead: Regulators Support: Market actors	- Water metrics increasingly embedded in national disclosure rules (e.g. CSRD, EU Taxonomy) - Progressively align reporting practices with ISSB/TNFD frameworks for water
	Sectoral policy alignment	- Build joint strategies to link financial flows with water resilience objectives (across agriculture, energy, urban development)	Lead: Cross-government taskforces	- National strategy linking finance and water adopted - Budget lines or incentives aligned with water resilience
	Widen regulatory ecosystem	- Advance due diligence on water in value chains (e.g. for agriculture, apparel, mining) - Expand legal requirements for water-related risk management	Support: Regulators, public banks	- Mandatory water due diligence adopted in one or more sectors - Regulatory guidance issued
Long-term	Mainstream water risk in macro-financial policy	- Embed water risks in central bank macroeconomic modeling, monetary policy, and macroprudential strategies - Institute structural reforms for water pricing and allocation	Lead: Legislators	-Water-related risk variables included in macro-financial models - Policy frameworks strengthened to improve water allocation and align economic instruments (e.g. pricing, tariffs, permits) with resilience goals
	Strengthen enabling frameworks	- Fully align supervisory, disclosure, and market standards on water (taxonomies, due diligence, etc.) - Promote water-resilient investment across financial and real sectors	Support: Market regulators	- Water risks systematically integrated into supervisory and disclosure frameworks - Water criteria (e.g. in green taxonomies or investment standards) actively used in investment screening and labelling
	Global alignment and participation	- Advocate for global architecture (standardisation) for water-related risk in international policy (G20, UN, FSB)	Lead: Macroeconomic authorities	- Water risks explicitly recognised as systemic in global financial governance statements (e.g. G20, FSB, IMF) - Roadmap agreed for integrating water-related risk standards into international financial regulation and disclosure frameworks - Global dialogues reflect the economic value and public good nature of both blue and green water

Source: Authors.

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