Banks unprepared for climate risk to mortgages, warns RBA

A top official at the Reserve Bank of Australia (RBA) has delivered a much-anticipated speech regarding the central bank’s approach to climate change. His remarks shed light on some key elements of how the RBA understands climate risks to the country’s financial system and on its strategy to address them.

Banks unprepared for climate risk to mortgages

Jonathan Kearns, head of domestic markets, warned that banks have less experience than insurers in modelling the financial impacts of climate events, and so have more work to do to develop management of the associated risks.

He said the impact of climate change on mortgages is likely to be significant but uncertain, in part due to their long time horizons. He added that mortgages may end up having a much longer maturity than currently anticipated, because climate risks may pose particular difficulties for homeowners in refinancing and upgrading their properties.

According to Kearns, climate change may also prevent borrowers from reinsuring their property as providers raise premiums or even decline to serve certain neighbourhoods altogether.

“If climate change means a home isn’t insured, then lenders could find that damage from flood, storm or fire results in the collateral value being significantly lower, and so their expected loss given default on climate-impacted properties is much larger,” he said.

The Bank of England issued a similar warning in June following the results of its first climate stress test, which found that millions of UK households could be forced to go without insurance in the event that insufficient action is taken to arrest rising temperatures.

Disclose climate risks to avoid litigation, banks and funds told

Kearns warned that insurers, banks and super fund trustees all face liability risk if they do not disclose, address and manage the effects of climate change sufficiently for their customers and owners.

He said providing detailed information on institutions’ exposure to climate risk is important in managing their liability risk.

In 2020, legal action by a member of the AUS$57bn Retail Employees Superannuation Trust led to a settlement in which the pension fund agreed to incorporate climate change financial risks in its investments and implement a goal of achieving a net-zero carbon footprint by 2050.

Green finance taxonomy could include LNG

Kearns said developing an Australian green finance taxonomy is a key priority for the RBA and its fellow regulators. However, he hinted that the country may adopt a less restrictive approach than other jurisdictions towards including “transitional” sectors such as liquid natural gas (LNG).

He said that having widely recognised and utilised definitions of what is sustainable increases the quality and consistency of information available to financial market participants, and so improves management of climate risks.

But Kearns suggested that, given Australia’s relatively high carbon intensity, the early stages of its path to net zero may involve investments that reduce total carbon emissions but are not purely green, citing LNG as an example.

He concluded that, while the EU taxonomy may not label LNG as a green investment unless it meets stringent requirements, the Australian taxonomy could recognise that increased use of LNG might assist a transition away from coal while the infrastructure for renewable energy production is developed.

Australia still burns coal for most of its electricity. Former RBA deputy governor Guy Debelle warned last year that investors were considering divesting from the country over concerns about its inaction in addressing climate change.