Banks are planning to tap into the €7 trillion European mortgage market to develop green mortgages as a way of limiting their exposure to climate change and potentially future risky assets.
Mortgages account for a third of the European banking sector's assets. With the majority of European buildings in need of renovation, lending money to make a house more energy-efficient is essential if the financial sector wants to play a major role in bringing the region's economy in line with 2015 Paris Agreement on climate change, market participants say. The Paris accord aims to limit the rise in global temperature to 2 degrees C above pre-industrial levels.
Banks are already starting to dabble in energy-efficient mortgages, often described as green mortgages because they take into account new buildings and renovations to existing houses that are environmentally friendly, with the U.K.'s Barclays PLC launching a green mortgage in April and Sweden's Skandinaviska Enskilda Banken AB in May.
In addition, 37 European banks, accounting for €3 trillion of the EU's lending market, including Groupe BPCE, ABN AMRO Group NV and Société Générale SA, launched a pilot scheme in June to develop mortgages over the next two years at lower interest rates for borrowers who buy energy-efficient homes.
Gabriel Lundström, SEB's sustainability manager for corporate and private customers, expects mortgages for energy-efficient homes to be a "regular product" in the next two years once customers get to know them better and banks perfect them as a way to protect themselves from longer term risk.
"We believe these [energy-efficient] properties will be better from a risk point of view because they have lower running costs and they often are built with good materials," Lundström said.
One of the major challenges for the European banking sector is that the mortgage market is highly fragmented, with different insolvency laws, valuation methods and energy certification.
The mortgage pilot scheme aims to create common guidelines that will encourage banks to offer energy-efficient mortgages, said Luca Bertalot, secretary general of the European Mortgage Federation, and coordinator of the EU-funded Energy Efficient Mortgages Initiative, which is helping to develop the European bank mortgage pilot scheme under its Energy Efficient Mortgages Action Plan.
While banks will have the commercial freedom to sell energy-efficient mortgage products in the way they wish, lenders involved in the pilot must adhere to the idea that banks should grant a larger mortgage to a borrower to pay for renovations to make a property more energy-efficient at a cheaper price than a regular mortgage, Bertalot said. Mortgages for properties that are already energy-efficient would be subject to a lower interest rate.
The risk of default should be lower because the borrower will have more disposable income due to lower energy bills, and the house's valuation will increase over time because it is more energy-efficient, he said.
"We are creating a model [which has] for the first time a link between the energy performance of ... the house and the financial performance of the mortgage, which means also the asset or the bond issued with this kind mortgage afterwards," Bertalot said.
Standardization of energy-efficient mortgages "would provide confidence to investors and will be the key to achieving scale in the market," said Stephanie Sfakianos, head of sustainable capital markets at BNP Paribas SA, which is participating in the project.
SEB's Lundström said there had been strong interest from investors in green covered bonds, and that starting an energy-efficient mortgage market was a way of responding to investor demand. Indeed, a recent S&P Global Ratings report said the green covered bond market has the potential to grow significantly as the green mortgage market develops.
Stephen Richardson, technical lead for energy-efficient mortgages at the World Green Building Council, which is helping to develop the European bank mortgage pilot scheme, said investor demand was driving in part the move toward standardization.
"There is a big chunk of that mortgage debt that is backed by the capital markets so investors want some kind of standardization of what constitutes energy performance and what constitutes green when they are issuing green bonds and buying green bonds," he said.
In addition, he said, legislation was becoming more stringent with regards to energy efficiency, and buildings not meeting new standards "will be a greater risk to the lender."
"This is all about mitigating and reducing that risk for the lender by incentivizing the borrower in the first instance to purchase a more efficient building to start with or to improve the efficiency of an existing building," he said, noting that this was particularly important in Europe where most countries have very old building stock.
The rate of energy-efficient renovation needs to treble to 3% if Europe is to meet its climate and energy goals, according to a Sept. 24 World Green Building Council report published under the EU-funded Energy Efficient Mortgages Action Plan. The plan has looked at ways in which consumers can save money with energy-efficient mortgages and how building renovation can help the EU meet its climate targets.
Market participants emphasize that energy-efficient mortgages are in their early stages, and what will be key in the coming years will be the data harvested on today's green mortgages, which will give details on energy efficiency, property evaluation and a borrower's salary, to help mold future mortgage products. Bertalot predicted that it could take up to 20 years to collate relevant data.
"It is a chicken and egg story. Either we will start now or we will never start," he said. "We have also to be practical here."
S&P Global Ratings and S&P Global Market Intelligence are owned by S&P Global Inc.