Financial Institutions and Deforestation Risk Management

May, 2018

The development of this study, which is a continuation of the report published in 2016 - “Risks and Opportunities Related to Natural Capital for the Financial Sector” – was motivated by four main factors: The first of them refers to the relevance of agribusiness for the Brazilian economy – taking into account that the sector accounts for 23.6% of GDP and is responsible for 46.6% of the country’s exports – and for bank credit portfolios – as just the rural credit contracted in the 2016/2017 Plano Safra (Agriculture and Livestock Plan) alone accounted for some 10% of the total individual and corporate lending portfolio.

Deforestation rates in the Legal Amazon and Savanna areas remain high. In the Amazon, the rate decreased by 16% in 2017 after increasing by 73% between 2012 and 2016, but it is still far from the national target of 3,925 square kilometers for 2020. In the Savanna area, the deforestation rate in 2015 (9,483 km2) was 52% higher than that of the Amazon in the same year.

It is necessary for the financial institutions to meet the requirements of the Manual de Crédito Rural – MCR (Rural Credit Manual) related to the environmental regularization of rural clients (Brazilian Central Bank Resolutions 4,427/2015, 4,422/2015 and others). Lastly, it is noted that there is a trend among the Brazilian public supervising bodies to hold accountable not only the agent that is directly responsible for the environmental damage, but also the different members of the value chain indirectly linked, including the financing agent, thus generating a greater legal risk to financial institutions.

Therefore, this study intends: (1) to improve the financial institution’s deforestation risk management practices by means of (1a) recommendations on criteria to be analyzed before granting credit and (1b) provide information on tools and databases available for consultation on deforestation risk; and (2) to provide subsidies to allow the banks to respond to the national and international demands related to deforestation reduction.

To achieve such objectives, the report is structured in three parts. The first of them maps the physical incidence of deforestation in selected agriculture supply chains and analyzes the way in which the companies of different links of the chain are managing the deforestation risk. The second part examines the requirements related to deforestation risk management to be met by financial institutions upon granting credit to rural producers and agribusiness corporate clients. It also identifies which of the main databases and tools in place are able to help the institutions to manage their risk. The third part concludes and makes recommendations on (i) which elements of the financial institutions’ socio-environmental risk analysis contribute to deforestation risk reduction of their clients in the agriculture sector and (ii) what are the available tools that contain the necessary information for such deforestation risk management.

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