European Central Bank working paper finds banks increasingly charge physical climate risk premia in euro area mortgage rates

The European Central Bank published Working Paper No 3036 assessing whether physical climate risk is reflected in banks’ residential mortgage rates. Using loan-level evidence, the authors find that mortgages secured on properties in higher physical climate risk areas are priced with higher interest rates at origination and that the average premium has increased in recent years, alongside marked heterogeneity across banks. The analysis combines mortgages originated between 2010 and 2023 in eight euro area countries (Belgium, Germany, France, Ireland, Italy, the Netherlands, Portugal and Spain) from the European Data Warehouse with location-based hazard scores from Four Twenty Seven and supervisory categorisations from the Single Supervisory Mechanism’s Targeted Review of Climate and Environmental Risks. Estimated effects range from about 4 to 37 basis points per standard deviation increase in climate risk, with pricing becoming positive and statistically significant from around 2016; significant institutions assessed by ECB Banking Supervision as “adequately” integrating climate risk into credit risk management charge higher and rising premia, particularly after the publication of supervisory expectations, while “inadequate” banks show little or no premium, consistent with ECB thematic review diagnostics. The paper notes that the impact of more intrusive supervisory actions from 2022 cannot yet be assessed with the available post-2023 origination data, and it recommends further embedding of climate risk in day-to-day bank credit processes alongside continued supervisory follow-up. The paper does not represent the views of the European Central Bank.