Climate risks can harm Australian banks' mortgage portfolios and climate-vulnerable homes may also be difficult to insure according to Reserve Bank of Australia (RBA).
RBA head of domestic markets Jonathan Kearns has said that if the physical impacts of climate change erode the value of a home, a mortgage borrower may find it hard to refinance or move.
Speaking on Managing Financial Services Risks in an Age of Uncertainty Mr. Kearns said, “The lender may then find that the loan on that property has a much longer realized maturity and the collateral backing the loan has a lower value.”
He said, “Climate-vulnerable homes may also be difficult to insure either because insurance companies won’t cover them or because the policies are too expensive. This poses a risk to banks, because uninsured home values could drop sharply following floods, storms, or fires. The lower the value of the underlying mortgage collateral, the greater the potential loss a bank would suffer should the mortgage borrower default.
“Climate change risks can manifest in different ways for different types of financial entities. If financial entities mismanage their climate risks, they are also exposed to liability risk,” said Mr. Kearns.
He said general insurers have a bit of a head start in managing the financial risks of climate change. First, because their policies make payments for damage from extreme weather events, insurers already have in place systems for assessing the likelihood and cost of these events.
“The frequency and severity of these events is, however, generally increasing, and so insurers need to plan accordingly, including for larger potential losses,” said Mr. Kearns.
Second, premiums on general insurance policies are typically repriced annually, which provides a regular interval for insurers to reassess risks. So insurers can adjust their premiums, or even decide not to write policies in some locations, as climate change alters the pay-outs they may have to make.
Mr. Kearns said, “Such a reduction in insurance coverage could have significant implications for the society, the economy and the financial system. Also, the fact that insurers can later decide not to provide cover means asset owners should not take comfort from being able to insure climate risks at this moment in time.
He said, “Some other insurance policies, such as life insurance, have longer periods over which payouts might need to be made, but they generally have less direct exposure to climate change.”