Assessing the materiality of nature-related financial risk for the European Union: a narrative-based approach to scenario development

Nature in Europe is facing a ‘serious and continuing decline’ (EEA, 2025) with less than 40% of its surface bodies achieving ‘good’ ecological status and over 80% habitat assessments achieving ‘poor’ or ‘bad’ conservation status (EEA, 2024). Europe is not on track to meet its targets on water, climate or energy by 2030. Local as well as global environmental degradation pose a risk to the economy given the connection between the global economic system through supply chains and the financial system (Ranger et al., 2024). Nature loss can lead to systemic financial risks through compounding effects, cascading effect and/ or financial contagion (NGFS, 2024).

Following the scenario development methodology in Ranger et al. (2024) - based upon a combination of narrative scenario development coupled with a quantified macroeconomic model - we develop a nature-related risk scenario for Europe driven by domestic environmental degradation to understand the potential impacts of nature degradation on financial stability. The approach for scenario design is consistent with IMF (2019)’s guidance on scenario for stress-testing which focusses on plausible yet extreme shocks and learns from the literature on narrative scenario development as well as robust decision making. First, we develop a Nature-related Risk inventory for Europe (NRRI-EU) —a long- list of over thirty nature-related risks to Europe and assess the likelihood of each risk materialising in the next 5-10 years. We validate the NRRI-EU by liaising with natural sciences’ experts and gathering feedback on both the list of risks included, the classification on the likelihood of these risks materialising in the short-term (5-10 years) as well as the confidence in that assessment. Second, we analyse the interactions between these risks to identify whether some risks could co-occur driven by shared driver/s or feedback processes. Third, we develop a cluster of interrelated risks which enable identifying compounding shocks for the scenario design. Fourth, we develop a narrative domestic scenario including both chronic and acute impacts. Next steps include parametrising the narrative scenario into individual shocks (some of these compounding and, possibly cascading) based on the latest literature to quantify the macroeconomic impacts.