How South American Central Banks are Preparing for Environmental Financial Risks

Governments have traditionally addressed environmental risks through fiscal instruments such as cap-and-trade systems and subsidies for new energy technologies. And policies related to resilient development have largely remained within the fiscal domain. But while fiscal tools are effective, they are insufficient on their own, as environmental-related risks increasingly intersect with the core mandates of monetary authorities, including inflation control and financial stability.

That is where a technical cooperation by the Inter-American Development Bank (IDB) aimed at research and regional cooperation comes in. The IDB Research Department is currently supporting eight South American central banks – Argentina, Brazil, Chile, Colombia, Ecuador, Paraguay, Peru, and Uruguay – in developing more effective analyses and policies to build resilience to environmental shocks.

Central banks, which have significantly strengthened their technical and analytical capacity over recent decades, are well-positioned to help address these risks. In this case, they are strengthening their analytical tools, research, and regional cooperation to better assess and manage nature-related financial risks, helping safeguard resilient and stable financial systems.

Moreover, in South America, where evidence shows that droughts, floods, heat waves, and El Niño events can significantly affect credit growth, loan performance, and inflation, they also have much to gain from regional collaboration and a shared analytical framework that can help them manage those threats.

Meeting in Paraguay to Exchange Ideas

A key event was a meeting on March 19, 2026, in Asunción, Paraguay, hosted by the Central Bank of Paraguay, where economists from the participating central banks exchanged ideas, shared experiences, and presented ongoing research at the intersection of environmental risks, financial stability, and monetary policy. All those efforts are aimed at building analytical capacity across the region.  

The meeting and the technical cooperation come at a critical time for central banks, which, to fulfill their core mandates of price and financial stability, may find it necessary to monitor the financial system’s exposure to uncertainty related to extreme weather events. Financial institutions with loan portfolios concentrated in vulnerable regions or sectors can face heightened exposure to environmental shocks. When such risks materialize, they can weaken banks’ ability to provide financing and risk-transfer services that are essential for economic recovery after natural disasters. For that reason, central banks, acting as both monetary authorities and financial regulators, play a key role in evaluating these types of financial risks.

Natural disasters can destabilize banking systems through both physical risks (damage caused by extreme weather events) and transition risks (economic adjustments associated with the shift to a sustainable economy). These can translate into broader financial vulnerabilities, including those related to liquidity and credit. The issue is particularly relevant in Latin America and the Caribbean, where banks dominate the financial system. Unlike in other regions where capital markets play the leading role, banks in the region hold most financial savings and serve as the main channel of financial intermediation, transferring funds from savers to borrowers. Thus, instability in the banking system can significantly affect savings, investment, and overall economic growth in the region.

Addressing Common Regional Challenges

Given these common regional challenges, the technical cooperation is structured around three main components:

1. Regional strategy and action plans (agreement and direction): Developing a shared understanding of the evolving role of central banks in responding to environmental shocks and identifying appropriate policy instruments. This includes online meetings, seminars, and policy dialogues.
2. Analysis and research (building evidence and expertise): Enhancing the ability of central banks to assess nature-related financial and monetary shocks through data development, research initiatives, and support for conferences. This work strengthens institutional capacity and promotes knowledge sharing across countries.
3. Methodologies and tools for regional application (practical implementation): Providing guidance on how central banks can manage risks related to natural disasters by developing stress-testing frameworks and macroeconomic models, in collaboration with central bank economists. It also includes workshops to facilitate the application of these tools.

The Importance of Stress Tests

Some central banks have already begun developing nature-related stress tests under the technical cooperation to assess how the banking system might perform under different environmental scenarios. These tests evaluate the resilience of financial institutions to both physical and transition risks, helping identify vulnerabilities in loan portfolios and providing early assessments of potential systemic shocks. By encouraging commercial banks to examine their exposure to such phenomena, central banks can foster preventive measures that protect bank solvency, profitability, and liquidity.

Several central banks are examining the financial and price stability implications of one of the most significant extreme-weather events in the region: droughts. Research from Argentina shows that during the 2022-2023 drought, credit growth declined and non-performing loans increased among drought-exposed firms compared with non-exposed ones. This, however, had no discernible systemic effect on banks. In Colombia, studies have found that drought events can undermine the solvency of firms in the hydropower sector, limiting their ability to meet financial obligations and thereby increasing credit risk for financial institutions. In Uruguay, environmental shocks affecting agriculture – such as heatwaves, droughts, and wildfires – increase banks’ expected credit losses. In Chile, 27% of commercial loan portfolios are exposed to natural disaster risk. Finally, in Ecuador, ongoing research shows that precipitation and temperature shocks across regions influence inflation dynamics nationwide.

Other central banks are studying the macro-financial effects of the El Niño phenomenon. In Brazil, a physical risk stress test indicates that a stressed-environment scenario raises the share of problematic assets in banks’ portfolios. In Paraguay, moderate El Niño episodes are estimated to increase core inflation, depreciate the exchange rate, and raise the stressed non-performing loan ratio. Evidence from Peru suggests that a higher probability of an El Niño event has a net positive effect on credit growth and bank capitalization.

By bringing together central bank economists, the IDB workshop in Asunción provided a platform for exchanging these experiences, as well as models, methodologies, and other research findings. It contributed to aligning perspectives on the evolving role of central banks and advancing a shared regional approach to these challenges. In the process, the discussions underscored how the IDB’s support is strengthening the region’s capacity to analyze nature-related financial and monetary risks, develop practical tools, and design strategies to build more resilient financial systems.