High water, no marks? Biased lending after extreme weather

Abstract

Policymakers have put forward proposals to ensure that banks do not underestimate long-term risks from climate change. To examine how lenders account for extreme weather, we compare matched repeat mortgage and property transactions around a severe flood event in England in 2013-14. First, lender valuations do not 'mark-to-market' against local price declines. As a result valuations are biased upwards. Second, lenders do not offset this valuation bias by adjusting interest rates or loan amounts. Third, borrowers with low credit risk self-select into high flood risk areas. Overall, these results suggest that lenders do not track closely the impact of extreme weather ex-post, and that public flood insurance programs may subsidise high income households.

Heat projections and mortgage characteristics: evidence from the USA

“…Ouazad and Kahn (2019) document the sale of riskier disaster area mortgages to government-sponsored enterprises (GSEs) in the aftermath of natural disasters. Garbarino and Guin (2021), however, find no reaction from mortgage lenders in England after the severe flood in 2013-2014 concerning local house price valuations, interest rates or loan amounts. Looking at bank lending to firms, Jiang et al ( 2019) find higher interest rates to firms geographically exposed to SLR.…”

“…Baldauf et al 2020;Murfin and Spiegel 2020). Another strand of research focuses on mortgage lenders' reaction as climate change risk becomes more salient due to, for example, natural catastrophes or abnormal weather-rather than relying on scientific projections (Garbarino and Guin 2021;Duan and Li 2019). A US-downscaled version of global climate models represents the cornerstone of our study.…”

The Impact of Natural Disasters on Banks' Impairment Flow: Evidence from Germany

“…Some studies also focus more explicitly on the pricing of disaster risk. Garbarino and Guin (2021) find that lenders fail to update their valuation of collateral in areas of continued flooding in England, and hence, seem to underprice climate-related credit risk when studying mortgage and property transactions in the UK around a severe flood event in 2013-14. In contrast, Brown et al (2021) provide evidence that banks indeed charge higher interest rates and tighten credit standards for borrowers increasingly relying and extending their credit lines following abnormal winter weather affecting part of the US during 2014-15.…”

Climate risks and their implications for commercial property valuations

“…This is another aspect on which research is scant. Studies of residential lending suggest that underwriting has been unresponsive to changes in information about climate risks (Garbarino and Guin, 2021; Keys and Mulder, 2020). The different nature of commercial real estate loans, lenders and borrowers makes this an area where more research is clearly required.…”