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May 22, 2023

How Financial Institutions are Using Climate Metrics for Mortgage Risk Decision-Making


By Kevin Cei, Head of Solutions Architecture, Jupiter Intelligence

In recent years, there has been a growing awareness of the risks posed by climate change to financial institutions and their mortgage portfolios. As a result, we've seen a rise in climate and sustainability initiatives being added to traditional risk roles.

These institutions are tasked with understanding the potential impact of climate change on their organizations and developing strategies to mitigate those risks. Jupiter works with some of the world’s largest financial institutions to help them understand their physical climate risk.

When it comes to the level of maturity across banks and lenders, we can assess financial institutions (FSIs) on a scale of 1-5 based on our extensive work with many of these organizations. Level 1 on the maturity scale is defined as somewhat new to climate risk analysis and mostly looking at using climate data to meet regulatory requirements, whereas Level 5 is defined as being deeply steeped in climate risk analysis and integrating the data into strategic decision making. Based on our observations, FSIs want to move higher on the maturity spectrum, but most fall in the 1 to 2 maturity range. That said, just two years ago, Jupiter saw more financial institutions at level 1 than we do today as they are progressing along their journey towards better understanding and management of climate risks. Read more about the Climate Resilience Maturity Index here.

To support financial institutions on this journey, Jupiter provides them with physical climate data based on rigorous science that helps them understand the impact of climate change on their organizations. This includes understanding basic hazards such as floods, wind, and heat, as well as the less obvious impacts of those hazards, such as cost of colling and impacts on worker productivity.

Banks and financial services providers are primarily looking at the most familiar aspects of climate change risk, such as changes in asset value, credit risk, and correlation with existing and understood risks. However, to make informed decisions, the climate data they use must be of high quality. For example, Jupiter makes data available at 90-meter resolution so banks can look at a climate assessment at the individual asset level. There is a lot of climate data in the market, but much of which has not gone through the rigorous science and machine learning for making strategic business decisions. 

One critical question financial institutions must consider is whether the current value of an asset is different from what it could be in the future due to physical climate change. We can make an assumption about the impact of climate change on asset value based on probability and science, rather than fortune telling.

For lenders using climate data, they may realize that certain areas will have lower property values due to the increased costs of repairs, utilities, and insurance from climate perils. By looking at basic home values and total cost of ownership, they can calculate a climate-adjusted loan-to-value ratio for loss and default risk measures as well as commercial risk.

For example Jupiter partnered with Bain & Company to examine data on mortgage portfolios in Italy

According to the report, in Italy, twice the number of assets will be exposed to high risk and three times more assets exposed to very high risk of fire by 2050. The damage could then worsen already eroded margins via a 7- to 10-percentage-point reduction in the profitability of newly originated mortgages over a 10-year period. The magnitude of this hit to profits raises the stakes for banks to clearly understand how physical risks can affect their portfolios. By comparing today's values to those from 10 and 20 years in the future, we can estimate how much banks will lose on their investments over time. 

Physical climate change is a significant risk to financial institutions, and it's essential that they understand and manage that risk. While some institutions are further along in this journey than others, many are looking for ways to get started. By providing high-quality physical climate data, Jupiter can help these institutions make informed decisions and mitigate risks associated with climate change. Let us help your organization get started today. 

Kevin Cei is the Head of Solutions Architecture at Jupiter.

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