From flood to fire: is physical climate risk taken into account in banks’ residential mortgage rates?

Physical climate risks can have a large regional impact, which can influence mortgage loans’ credit risk and should be priced by the lenders. Motivated by the relevance of climate change for financial intermediaries, our paper aims at analysing if physical climate risks are being reflected in residential real estate loan rates of banks. We show that on average banks seem to demand a physical climate risk premium from mortgage borrowers and the premium has increased over recent years. However, there is significant heterogeneity in bank practices. Banks that were identified as “adequately” considering climate risk in the credit risk management by the ECB Banking Supervision charge higher risk premia which have been increasing particularly after the publication of supervisory expectations. In contrast, the lack of risk premia of certain banks shows that ECB diagnostics in the Thematic Review on Climate were accurate in identifying the banks that need stronger supervisory focus. JEL Classification: G12, G21, Q51, Q54, R32