Most egregious is the push towards regulatory subsidy for green mortgages, as promoted by a swathe of covered bond-issuing banks behind the EeMAP (Energy efficient mortgages action plan) initiative.
The banks, which include ABN Amro, Berlin Hyp, BNP Paribas, Caja Rural de Navarra, CFF and Crédit Agricole, have in many cases issued their own green bonds, or supported the market in other ways — as lead managers, arrangers or investors in green issues.
Their motives are not suspect — many of the institutions involved have a deep and sincere desire to lead the transition to a low carbon economy and have been prepared to support any number of worthy initiatives with cold, hard cash.
It’s hard to blame them for arguing that regulators should recognise this good behaviour. Just as regulators will always over-engineer, bankers will always argue that their particular corner of the capital markets merits special treatment.
The case for green mortgages goes something like this — if a homeowner installs some set of green home improvements, they should benefit from a lower cost of funding for their mortgage, because the green improvement should save them money, raising disposable income (and therefore mortgage affordability) at the same time as the improvements raise the value of the home (thereby lowering LTV).
Neither statement is wrong, exactly — but the improvement in disposable income is at best negligible, while any improvement in LTV can be recognised… as an improvement in LTV. Both the new standardised approach to mortgage credit risk and the internal ratings-based approach recognise the LTV of mortgage lending (and, borrower affordability, weakly defined) as inputs into risk modelling.
If a homeowner were to make a series of environmentally destructive home improvements — a round of tropical mahogany flooring, an outdoor hot tub, patio heaters, air conditioning — it would have the same effects on credit risk as green improvements. In an ideal world, home surveyors and purchasers would deplore the wasted carbon involved, but in the real world, such things translate into higher house valuations.
Recognising these improvements twice, once as an ordinary risk input and again as a green input, implies cutting the capital allocated against the mortgages below the standards mandated by ordinary risk-based capital regulation.
There are sound arguments that recourse mortgages, even at the 15% risk-weights prevailing in some northern European jurisdiction, are overcapitalised. But institutions should argue for lower risk-weights because their assets are less risky — not because they are more green.
If existing risk management structures struggle to capture home improvements, change those structures, rather than tinker with risk weights. There may even be room for European rules along the lines of the US “PACE” loans (property-assessed clean energy), which sit super senior — but which stay with the property, not with the mortgagee. These loans have been controversial in the US, but they’re more transparent, at least, than below-the-radar tweaks to mortgage capital requirements.
While green banking lobby groups argue for capital cuts for their products, regulators are pushing hard to restore the credibility of risk-based capital ratios. Initiatives such as Basel IV, the Targeted Review of Internal Models, stress-testing and the leverage ratio are all geared at making risk-based capital more rigorous.
When capital ratios are subverted to politics, though, it undermines all of this work. Europe’s policymakers should do what they can to encourage green financing — but special pleading on prudential capital isn’t the right tool.