The current CRR3 proposal offers only incomplete clarifications, by suggesting that the collateral values of energy efficient mortgages should be “unequivocally” higher, indirectly suggesting a reduced amount of capital provisioning across the board for all mortgages collateralized by energy efficient buildings.
However as pointed out in the EBA discussion paper there are more dimensions to this issue to be considered. The CRR3 proposal should be further refined in order to provide meaningful risk-based capital buffers and constructive incentives for banks to hardwire energy efficiency considerations in their business approach and risk reduction strategies.
In our view, the prudential framework should be adjusted accordingly in the following way:
1. Higher risk weights should be applied for residential and commercial mortgages when collateralized by real estate properties with an EPC score of E, F or G, to reflect higher probability of default from the borrower, in particular in the current context of high energy prices, which increase the credit risk due to risk of default from mortgage customers with a poor energy performance, which are more vulnerable to more expensive energy bills due to income constraints (as outlined in the recent ECB Climate stress test results). The benefits of imposing stronger capital requirements would be two folds: (1) it would ensure banks are accurately provisioning against possible future losses from vulnerable mortgagees, and (2) as a side-effect it would encourage banks take proactive measures to reduce their risk exposure, for example by helping their consumers willing to purchase real estate properties with a low EPC score to also consider carrying out energy efficient renovation right away. In these circumstances, banks should consider offering consumers a supplementary loan to cover the cost of the renovation (see point 2).
2. Loans for energy-efficient renovation purposes (eg. offered in supplement to a mortgage for home purchase) should be encouraged and could be subject to lower capital requirements under certain conditions (ie. the renovation should lead to a reduction of energy primary demand of at least 30%, as defined in the EU Taxonomy). Lower capital requirements should proportionately reflect improvements in the risk profile resulting from the improved energy efficiency, especially for mortgage customers most exposed to risks associated with higher energy prices (ie. with an EPC score lower than D). In the case where the renovation loan supplements an underlying mortgage, the risk weighting applied on the underlying mortgage could be adjusted to reflect the credit risk mitigation, upon completion and certification of the energy efficiency renovation work (the adjustment should be applied ex post).
3. Reducing capital requirements on mortgages whose real estate collateral already have a high energy efficiency performance (eg. EPC score A) is not warranted. Indeed, green mortgages do not automatically imply an improvement in the borrower's creditworthiness, even though it theoretically increase the asset value. Furthermore other climate-related financial risks (such as flooding) may still affect even the most energy efficient buildings. Furthermore, From a climate policy perspective, granting incentives in the form of prudential requirements reliefs on green buildings would create only very limited benefits in terms of accelerating the speed of the EU renovation wave strategy, as no further energy efficiency gains would be obtained through such measures. On the contrary, it could create counter-productive incentives whereby banks restrict mortgages lending towards the purchase of low-energy-efficient real estate properties, while intensifying their lending towards buildings with high EPC scores. Such a strategy would induce a risk of fuelling a green home bubble with no tangible benefit in terms of enhancing additional energy efficiency gains, and possible negative side effects in terms of distribution of ownership of real estate properties, since green homes would become more expensive and less accessible.
Last but not least, it is obvious that transparent and qualitative data on the energy-efficiency performance of real estate collateral will be critical to justify all the above mentioned measures. Banks should be obliged to collect and disclose EPC data on their entire portfolio, (both at loan origination level for new loans, and on their entire existing stock of loans), to neutralise risk of banks developing avoidance strategies by pretexting the lack of data, or to apply inaccurate proxy data in order to fictitiously increase the energy efficiency profile of their mortgages portfolio.