Property values are at risk in climate change hot spots, RBA warns

Property in parts of Australia exposed to climate change and wild weather could experience valuation declines that leave banks with less protection in the event of a default, according to Reserve Bank research.

About 3.5 per cent of dwellings in Australia already fall under an international definition of being at “high risk” from climate damage, RBA economists Kellie Bellrose, David Norman and Michelle Royters said in a research paper.

But the RBA economists note that it’s the rise in climate risk that isn’t yet reflected in property prices that’s key when considering the banks’ exposures in climate-sensitive regions.

Rising sea levels, eroding beaches: Climate change could deliver a significant hit to property values in affected areas, the RBA says.Credit:Nick Moir

The problem could be acute in Australia, the world’s driest inhabited continent, as mortgages account for about two-thirds of the big banks’ portfolios, according to the research.

“Climate change creates risks for the Australian financial system that will rise over time to become substantial if they are not properly managed,” they wrote. “If current values do not fully reflect the longer-term risks of climate change, housing prices could decline, leaving banks with less protection than expected against borrower default.”

The regions projected to see the biggest rise in the proportion of properties as high risk out to 2050 include highly populated areas in southeastern Queensland and northern NSW, which have a large number of houses at risk of coastal inundation.

‘Climate change creates risks for the Australian financial system that will rise over time to become substantial if they are not properly managed.’

To estimate potential climate change impact on mortgage books, the researchers translated estimated falls in housing prices in climate-sensitive suburbs by 2050 into an implied change in borrower leverage, as measured by loan-to-value ratios.

The outcome suggests climate change will result in around 400,000 more loans, or 2.5 per cent of all loans, having a loan-to-value ratio greater than 80 per cent. Within this, around half move to greater than 90 per cent.

Classifying a dwelling as “high risk” is based on the so-called value at risk (VaR) — that is, the annual expected cost of climate-related damage relative to the replacement cost of dwellings — exceeding 1 per cent.

A VaR change of 0.4 percentage point is equivalent to roughly a 10 per cent decline in housing prices due to climate risk, according to the paper. Increases in insurance premium costs “would be incurred every year, and therefore could result in sizable declines in property values.”

The authors acknowledged limitations to this method. The risks to banks “may be overstated in this exercise because we assume that banks’ exposures will not change in the future,” though banks are expected to increasingly incorporate climate risks into their lending decisions.

Bloomberg

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