The latest ECB climate stress test shows that banks could face a wave of insolvencies on their mortgage lending as high energy prices hit consumers with energy-inefficient homes. Banks’ unpreparedness to collect data on the energy efficiency of their real estate exposures exacerbates this risk even more. This is a wake-up call for the EU and governments to urgently strengthen supervision and oblige banks to unlock finance for the renovation wave.

On July 8th, the ECB published the results of their climate stress test, an exercise involving 108 banks across Europe aimed at understanding how climate change could impact their business in the next 30 years.

Under the stress test exercise, the banks’ lending portfolios are confronted with various orderly and disorderly transition scenarios, including extreme weather events and energy price shocks. By simulating these scenarios, the stress test can model the potential losses that will occur on the banks’ balance sheets.

Without surprise, the results show that banks still do not pay enough attention to climate risks, and that they have managed very little improvement since the previous exercise conducted in 2020.

For the first time, the stress test methodology incorporated an analysis of how banks are exposed to risks of mortgage default by factoring in the energy performance of buildings. The participating banks thus had to input into the stress test model information on the energy efficiency of their mortgage holders’ houses, such as energy performance certificates (EPCs), or by using proxy data (such as energy bill payments, date of construction of the buildings, or the size of the real estate property).

The results show a clear correlation between the energy efficiency of real estate properties and credit risks, with the latter being three times higher for a property with an EPC score of G than for those with an A score.

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