Elena Johansson writes on the Expert Investor Europe website about a report from an EU-funded project found a significant negative correlation between buildings’ energy efficiency and the probability of mortgage defaults and supports the argument that green assets have a lower risk than non-green assets.
Evidence fuels argument to create ‘green supporting factor’
A recent report has provided evidence which backs investors seeking to promote that climate-related risks are integrated into the capital requirements of banks to accelerate the low-carbon transition.
It found a significant negative correlation between buildings’ energy efficiency and the probability of mortgage defaults.
The report was published by the Energy Efficiency Data Protocol and Portal (EeDaPP), a project belonging to the Energy Efficient Mortgages (EEM) Initiative.
EEM is a pan-European private bank financing mechanism that aims to stimulate and finance investment in energy efficient buildings and energy saving renovations. It is seeking to deliver a standardised European framework and data collection architecture for energy efficient mortgages and its projects are EU funded.
Dirty penalising factor
The report’s findings support the argument that green assets have a lower risk than non-green assets.
The evidence has so far been limited as to whether green assets have lower risk, according to a 2020 report by French think tank Institute for Climate Economics (I4CE).
It is currently being discussed at EU level whether this possible risk difference can be reflected by giving banks capital relief for their green lending and applying a discount to green loans, the so-called ‘green supporting factor’, one of different existing mechanisms.
Murray Birt, senior ESG strategist at DWS, told Expert Investor: “Policy changes such as a green supporting factor/dirty penalising factor are needed to accelerate real economy investment like more building retrofits.
“With many mortgage interest rates being very low from historical standards, a green supporting factor should help provide encouragement to homeowners to retrofit their homes while creating incentives for banks and investors to provide the necessary capital.”
Identifying incentives and mechanisms
But observers have warned that this discussion should not lead to a loosening of capital requirements, which have been increased after the global financial crisis to secure the resilience of banks and financial stability.
A spokesperson at the European Banking Federation told Expert Investor that an intelligent use of incentives is needed to encourage sustainable finance.
“When it comes to real estate that means introducing incentives in terms of tax for example, or a more favourable treatment in terms of risk weights for mortgages on sustainable finance projects, to encourage energy efficient investments.
“The feasibility of recalibrating the capital requirements for banks (known as the green supporting factor) can be considered, but any recalibration of capital requirements, based on data and the assessment of the prudential risk of banks’ exposures, would need to rely on and be coherent with the future EU taxonomy,” the spokesperson said.
But Birt explained that, while the EU’s taxonomy for existing buildings is a good starting point, it is likely not aligned with the Paris Agreement requirements.
Instead, he pointed to the Carbon Risk Real Estate Monitor (CRREM), an EU funded research project on energy efficiency tools, as the better approach, as it provides science-based emission reduction requirements for different types of buildings in major countries.
Birt said that CRREM is at the core of Paris-aligned investment guidance for the real estate sector: “For example, for a single-family home in Germany, by 2030, carbon intensity must decline to reach 28kg/CO2e/year on the road to near zero by 2050.
“Green mortgages and loans need to help us reach this type of target.”
Reception of the EeDaPP report
The analysed data was based on 72,980 individual mortgage loans in Italy.
According to the portfolio analysis, the percentage of more energy efficient mortgages has been increasing over the last decade, while less efficient properties are predominantly affected by default.
The report states that the econometric evaluations highlight a negative correlation between energy efficiency and the owners’ probability of default, confirming that energy efficiency investments tend to improve owners’/borrowers’ solvency. Additionally, the results indicate that the degree of energy efficiency also matters, ie more energy efficient buildings are associated with relatively lower risk of default.
Birt commented on the findings: “Central banks and financial regulators have made clear that they need evidence before creating a green supporting factor or dirty penalising factor. The report on Italian mortgages from the EeDaPP is exactly the type of evidence needed to convince policymakers, joining reports from the Bank of England and others.”
Luca Bertalot, EeMap project coordinator and EMF-ECBC secretary general, told Expert Investor that “the results of this research will hopefully be taken in consideration when implementing Basel III in the European legislation and energy efficiency parameters will be captured in risk weighting calibration when designing the new European prudential policies”.
The EEM initiative is supported by 61 pilot banks, 44 supporting organisations and 17 European & international organisations, Bertalot said.
“The EEM initiative is gaining strong support in the market and also central banks are reviewing their approaches towards energy efficiency performances; for example, the Hungarian central bank which recently introduced a privileged treatment for green mortgages in their prudential framework,” he added.
The European Banking Authority (EBA), an independent EU supervisory authority, has been tasked by the EU’s Commission to provide advice.
A spokesperson at EBA told Expert Investor that the legal deadline to assess the need for dedicated prudential treatment (or green supporting factor) is 2025, but that it is planning to publish a discussion paper between 2022-2024 on the topic.
At the same time, the Commission called for feedback on prudential regulation in the banking and insurance sector as part of a consultation (which ended in July) on the planned Renewed Sustainable Finance Strategy.
In July, the Commission launched a consultation on the review of the EU’s prudential rules for insurance and reinsurance companies (the so-called ‘Solvency II Directive’) to see how the insurance sector can contribute to the objectives of the European Green Deal and the Capital Markets Union.