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August 31, 2022

UK banks “can’t hit net zero” without green mortgages

Banks must green millions of residential mortgages to meet net-zero ambitions, but low take-up and insipid product incentives make this hard.

By Virginia Furness

green mortgages will be used to retrofit old buildings in the UK
Green mortgages will be used to retrofit old houses in the UK. (Photo by moodboard via iStock)
  • Residential homes make up a fifth of the UK’s greenhouse gas emissions and must be decarbonised to meet the aims of the Paris Agreement.
  • Green mortgages make up just 2% of Barclays’ and NatWest’s mortgage books.
  • Green Finance Institute and Greater Manchester Combined Authority launch partnership to promote retrofit finance.

As Britain’s banking sector grapples with unbundling its huge exposure to fossil fuels, a less prominent but equally important struggle to tackle another carbon-intensive sector is taking place.

For many UK banks, residential mortgages make up the bulk of their lending activity, and as such are responsible for a high portion of their Scope 3 emissions – those connected with a company but outside its direct control. At Nationwide, the UK’s third-largest residential mortgage provider, this means 80% of the bank’s financed emissions are linked to its mortgages.

Buildings are one of the UK’s most carbon-intensive assets. The 29 million residential homes in the UK account for around a fifth of the country’s greenhouse gas emissions, according to analysis by Nationwide. Improving the energy efficiency of the country’s housing stock will be crucial for the UK government’s commitment to deliver net-zero carbon emissions by 2050.

“[Banks] can’t hit net zero without a strategy in place for greening UK homes,” says Emily Farrimond, partner, expert in ESG and sustainability at consulting firm Baringa.

This means for lenders like NatWest, where residential mortgages were responsible for 3.2 million tonnes of carbon dioxide equivalent (MtCO2e) of its financed emissions in 2020 – its second-highest-emitting sector after agriculture (4.5 MtCO2e in 2020) – decarbonising its mortgage book is central to its ability to meet net zero.

This is no easy task. “It’s really tough, much more so than in corporate finance where things have been moving more quickly,” says Eric Usher, head of the United Nations Environment Programme Finance Initiative (UNEP FI). “But if you want to look at the whole portfolio, you have to look at mortgage lending [and work out] when you have a portfolio of ten million mortgages how to reduce [the emissions of] those by 50% by 2030 as science based scenarios require.”

The built environment – defined as the setting for human activity, such as homes, buildings and transport etc. – is one of the nine most carbon-emitting sectors the UNEP FI requires its Net Zero Banking Alliance (NZBA) members to set targets on. So far, no members bank have done so, but Usher says a framework to set targets in real estate is being developed to change this.

Beyond the need to meet net-zero targets, banks have plenty more reasons to act. For one, they may be exposed to considerable stranded asset risk – mortgages linked to houses with low energy efficiency ratings – as well as regulatory risk, such as penalties for financing properties with poor energy performance certificate (EPC) ratings.

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Green mortgages: a solution

Green mortgage products are a natural first step to overcoming these challenges but still remain a tiny part of the market, making up just 2% of overall mortgages at Barclays and NatWest, for example. Barclays launched its first green mortgage product in 2018. The bank issued green mortgages worth £502m in 2021, from a total mortgage book of £33.9bn that same year.

Green mortgages aim to finance and facilitate the acquisition or construction of green homes or activities that lower the environmental impact of housing by offering preferential interest rates on more energy-efficient properties. At NatWest this means purchasing or re-mortgaging a home with an EPC of A or B. In September, the Green Finance Institute (GFI), a think tank backed by the UK government and City of London Corporation, released, in partnership with the Loan Market Association, its voluntary Green Home Finance Principles (GHFPs), a best-practice framework that it hopes will set a benchmark for financing greener properties.

NatWest first offered green mortgages in October 2020, green re-mortgages in August 2021, and in November 2021 expanded to provide green buy-to-let mortgages. The bank is one of very few to have set a target in its residential mortgages sector, which is to ensure that 50% of its mortgage book is at or above EPC C, or an equivalent rating of C, by 2030.

In November 2021, NatWest issued a £600m green mortgages green bond, maturing in 2028, to support the issuance of green mortgages. In 2021, it had issued £728m green mortgages from a total mortgage exposure of £210bn, increasing the green portion by a further £234m in 2022.

… But who cares about them?

However, the low take-up of green mortgages could be a sign that many consumers are simply not engaged with the benefits of greening their homes. Nationwide reports that take-up of its products, such as cheaper borrowing to members making green home improvements and cashback rewards for members who buy greener homes, has been slow, while customer surveys at Barclays show most customers do not think about these issues.

“This highlights the wider challenges in improving the energy efficiency of homes, as personal expenditure is being prioritised on other things and is being limited by the increasing cost of living,” Nationwide says in its annual report.

However, after a slow start hampered by concerns about greenwashing and product quality, the GFI says it is encouraged by the development of the market, which has grown from just four products in 2019 to over 51 in the UK market today.

But new product development is not enough. Many are concerned the market is not developing fast enough, nor indeed addressing the most pressing challenge: retrofitting the millions of older UK homes where carbon emissions are the highest.

“The products we see today don’t solve the problem of making homes more energy-efficient, helping customers with their cost of living, or driving change for the banks themselves,” says Baringa’s Farrimond.

Poor financial perks

Many products, she says, offer a 1 basis point reduction in interest rates for properties in the A or B EPC band. This is essentially helping people who are already efficient, she says.

Indeed, personal finance site moneysavingexpert.com finds that the cost of a typical two-year fixed green mortgage is currently more expensive than the cheapest equivalent non-green mortgage on the wider market. The interest on a 75% loan-to-value two-year fixed non-green mortgage at Barclays, for example, is 3.2%, versus 3.34% for the green equivalent at NatWest.

However, rising interest rates could help catalyse the green mortgage market if banks are able to pass on more meaningful rate reductions to their customers, says Richard Roberts, inquiry lead at Volans, the agency behind the UK government-backed Bankers for NetZero initiative. “That will start to feed into a more significant uptake of these products,” he says.

Banks such as Lloyds, through its building society Halifax, and NatWest are aware of the need to retrofit badly insulated and inefficient properties. NatWest is planning to launch green “additional borrowing” later this year, which will support its existing customers to improve the energy efficiency of their homes.

Lloyds, which has set a £10bn by 2025 green mortgage target, already offers customer incentives such as cashback on £1,000 loans and grants to install ground-source heat pumps, but this remains small-scale.

Scaling up green mortgages

In an effort to scale up retrofit finance, GFI and the Greater Manchester Combined Authority (GMCA) launched an initiative to support energy-efficiency improvements in the Manchester Area on 2 August, although there is no detail on how much financial support will be provided.

“Local authorities are perfect partners for the work we're doing on the decarbonisation of housing because they have very deep knowledge of that building stock,” says Emma Harvey, programme director for the GFI’s built environment programme. “The majority of them have announced climate emergencies that have rapid targets and large funding gaps."

GFI is convening traditional banks, building societies, mortgage advisors and retrofit experts to launch a series of financial products to address this funding gap. These include the UK’s first property-linked finance scheme, which aims to replicate the success of the US’s Pace model, which mobilised around $10bn toward retrofitting buildings and homes in the US in the past couple of years.

Property-linked financing means the repayment obligations are passed on to the new homeowner, who benefits from the green upgrade and pays a small monthly fee or green service charge.

Whether rising interest rates boost the nascent green mortgage market remains to be seen, though the challenge of retrofitting or lowering emissions associated with existing housing stock appears to be the real challenge for both banks and homeowners.

Capital Monitor is hosting the Webinar series, Making Sense of Net Zero. Find out more information on NSMG.live.

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