Energy Efficiency of Real Estate Exposures – Feedback from the National Bank of Belgium

THE GOVERNOR your references your contact
Financial stability, AML control and prudential policy for banks Kim Creminger National Bank of Belgium SA company number:
Tel.: + 32 2 221 53 28 boulevard de Berlaimont 14 0203.201.340 our references kim.creminger@nbb.be 1000 Brussels RPR Brussels BELGIUM www.bnb.be Brussels, 11 May 2023 Energy efficiency of real estate exposures – Feedback from the National Bank of Belgium Madam, Sir, Climate change and the transition towards a more sustainable economy are likely to heavily affect the health of financial institutions and financial stability in general. The National Bank of Belgium (hereinafter "the Bank") has therefore been paying close attention to climate-related risks for several years.

Buildings contribute significantly to greenhouse gas emissions in Belgium. The energy efficiency of buildings serving as collateral for (mortgage) loans therefore has a major impact on the transition risk to which the Belgian financial sector is exposed. This is why the Bank published a circular1 in December 2020, in which it requested Belgian credit institutions and insurance companies to collect data on the energy efficiency of their real estate exposures and to take it into account in their risk management. Regarding buildings serving as collateral for new residential mortgage loans, the Bank also imposed the obligation to communicate this data to it starting from 2021.

European and international regulations and publications by supervisory authorities include expectations and best practices concerning the collection, reporting, and use of Building Energy Performance (BEP) data. The ECB published good practices following the thematic review of climate risk management by banks that it conducted in 20222. One can also cite the EBA report on the management and supervision of ESG risks3, the ITS relating to Pillar 3 on ESG risk disclosure4, the EBA guidelines on loan origination and monitoring5, and the explanations regarding the treatment of climate risks within the framework of Pillar 1 recently published by the Basel Committee on Banking Supervision in the form of FAQs6.

The Bank has recently evaluated the implementation of the aforementioned circular, notably based on individual interviews with reporting credit institutions. During these interviews, the institutions concerned were also questioned on the extent to which they take physical risks into account in their risk management. The annex to this letter presents the main conclusions of these analyses and interviews. Based on the information it has received, the Bank has already contacted Febelfin to adapt the relevant reporting. The Bank is well aware that access to regional BEP databases is crucial for the banking sector and therefore continues to support the sector in its efforts to obtain this access.

The table below presents the Bank's main expectations regarding energy efficiency. These expectations are commented on in more detail in the annex to this letter.

Main expectations of the Bank

• Banks must continue their efforts to obtain data on the energy performance of buildings (BEP) for new and existing mortgage loans. Regarding new mortgage loans, they must have a BEP certificate when it is a legal requirement, and regarding existing mortgage loans, they must take the necessary steps to obtain this certificate. If the BEP certificate is not legally required and is not available, banks may use supported estimates. For existing mortgage loans for which no BEP certificate is available, even after taking the necessary steps, supported estimates are also authorized.
• Credit institutions must further develop their framework for risk monitoring, energy efficiency risk appetite, and the associated transition risks, and provide sufficient internal concepts and tools to integrate energy efficiency into their risk management.
• Credit institutions must conduct in-depth risk analyses based on available data on transition risks and physical risks related to climate change. These analyses must enable them to (better) integrate energy efficiency into their risk management.

Please accept, Madam, Sir, the expression of our distinguished consideration.

Pierre Wunsch
Governor

Annex: 1
3 EBA (2021), EBA Report on Management and supervision of ESG risks for credit institutions and investment firms, June 2021.
4 Commission Implementing Regulation (EU) 2022/2453 of 30 November 2022 amending the implementing technical standards defined in Commission Implementing Regulation (EU) 2021/637 as regards the publication of information on environmental, social and governance risks.
5 EBA (2020), Guidelines on loan origination and monitoring (EBA/GL/2020/06), May 2020.
6 BCBS (2022), Frequently asked questions on climate-related financial risks, December 2022.

THE GOVERNOR
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Confidential

Annex: Overview of results and monitoring of circular NBB_2020_045
Collection of data on Building Energy Performance (BEP) Banks have made significant efforts to collect BEP data for new residential mortgage loans. However, in many cases, this data remains missing. This is why the sector must take new actions to improve the availability of such data.

If a BEP certificate is legally required, banks must have the BEP information. They can obtain it by integrating an obligatory field for the BEP score in the internal tools they use when granting a new mortgage loan. If the BEP certificate is not legally required and is not available, the Bank accepts supported estimates.

In the circular, banks were also invited to collect information on energy efficiency for existing residential mortgage loans with a residual loan-to-value ratio of more than 85%. It emerges from the interviews conducted by the Bank with banks that this type of data is generally not available, notably due to the lack of incentive for current clients to provide this information. If no BEP data can be obtained, credit institutions may use supported estimates. Given that it prefers actual BEP data, the Bank nevertheless expects financial institutions to take the necessary actions to collect this data, in cases where the BEP certificate is legally required.

Regarding investment loans secured by commercial or residential real estate or used to finance such property, as well as real estate investments, there is often no uniform methodology or market standard, so a BEP certificate is not always available. In this case too, the Bank allows the use of supported estimates for existing loans and investments. Regarding new loans and investments, it is however expected that institutions request the necessary information.

Integration into risk management
Banks must take new steps to integrate energy efficiency and the collected BEP data into their risk management and risk analyses. The interviews conducted by the Bank with credit institutions revealed that most banks focused primarily on collecting BEP data for new mortgage loans. It is important that this data is also integrated into their risk framework.

A best practice observed by the Bank in the field of risk management consists of using key performance indicators (KPIs) and key risk indicators (KRIs) for energy efficiency-related risks and transition risks. In order to identify certain risky segments, several indicators related to credit quality are coupled with these KPIs and KRIs. Like the latter, these indicators are regularly monitored and submitted to the competent decision-making bodies.

The Bank expects each credit institution to further develop its framework for risk monitoring, energy efficiency risk appetite, and the associated transition risks, and to provide sufficient internal concepts and tools to integrate energy efficiency into its overall risk management. To this end, it is necessary to use the information requested on building energy performance (BEP) as well as other data related to climate change risks.

In addition to transition risks, real estate is also subject to physical risks. The institution's risk management framework must also take these into account. Several banks do verify whether the real estate properties for which they grant a mortgage loan are not located in flood zones or are duly insured. The Bank expects each bank to do the same and not to assume that flood risks are and remain fully covered by insurers. Further integration of physical risks into their internal management in this regard is encouraged.

Since the introduction of circular NBB_2020_045, banks have had data on transition risks and physical risks related to climate change to which they are exposed. The Bank expects credit institutions to conduct in-depth risk analyses based on this information. This will enable informed decisions regarding the impact of transition risks and physical risks related to climate change on the valuation of collateral for granted mortgage loans and on the borrowers' repayment capacity. These analyses may lead to a refined and risk-based credit policy.

Appropriate risk policy
In many cases, banks' policies are not (yet) based on in-depth risk analyses. Better quality analyses would allow for a more precise and adequate integration of energy efficiency into risk policy. This would serve the achievement of long-term objectives regarding climate-related risks to which the financial sector is exposed.

Provision of advice
Some institutions are trying to reduce future risks related to climate change by encouraging their counterparties (companies and individuals) to reduce their exposure to these risks. For example, some institutions advise their counterparties on how to increase the energy efficiency of their buildings and provide them with information on available financing methods and subsidies. Future risks weighing on both financial institutions and their counterparties can thus be limited.

Adaptation of reporting
The interviews conducted by the Bank with several credit institutions indicated that BEP data, associated notably with information on credit standards applied (such as the loan-to-value ratio (LTV) or the proportion between the monthly payment and income (LSTI)), could be interpreted more adequately if the current reporting was – for certain aspects – at a finer level of detail. An adapted PHL reporting, which is still to be discussed with the sector, will notably include a distinction between actual and estimated BEP values and will integrate a breakdown of the purpose of the mortgage loan (purchase, new construction, renovation, purchase and renovation, etc.).

1 Circular NBB_2020_45 of 1 December 2020 on the collection and reporting of information on the energy efficiency of real estate exposures.
2 ECB Banking Supervision (2022), Good practices for climate-related and environmental risk management, observations from the 2022 thematic review, November 2022.