Energy Performance Certificate as One of Mortgage Default Determinants in the Czech Republic

• Název práce v češtině: Průkaz energetické náročnosti budovy jako jeden z determinantů nesplácení hypotéky v České republice
• Název v anglickém jazyce: Energy Performance Certificate as One of Mortgage Default Determinants in the Czech Republic
• Klíčová slova: průkaz energetické náročnosti budovy, hypotéka, nesplácení, úvěrové riziko, řízení rizik
• Klíčová slova anglicky: energy performance certificate, mortgage, default, credit risk, risk management
• Akademický rok vypsání: 2021/2022
• Typ práce: bakalářská práce
• Jazyk práce: angličtina
• Ústav: Institut ekonomických studií (23-IES)
• Vedoucí / školitel: Mgr. Magda Pečená, Ph.D.
• Řešitel: skrytý - zadáno vedoucím/školitelem
• Datum přihlášení: 14.06.2022
• Datum zadání: 14.06.2022
• Datum a čas obhajoby: 11.09.2023 09:00
• Místo konání obhajoby: Opletalova, O314, místnost. č. 314
• Datum odevzdání elektronické podoby: 01.08.2023
• Datum proběhlé obhajoby: 11.09.2023
• Oponenti: Mgr. Josef Švéda

Seznam odborné literatury

Basel Committee on Banking Supervision (BCBS). 2021. Climate-related financial risks – measurement methodologies. Bank for International Settlements. https://www.bis.org/bcbs/publ/d518.pdf
Battiston, Stefano, Antoine Mandel, Irene Monasterolo, Franziska Schütze, and Gabriele Visenti. 2017. "A climate stress-test of the financial system." Nature Climate Change 7.4: 283-288. https://doi.org/10.1038/nclimate3255
Baudino, Patrizia, and Jean-Philippe Svoronos. 2021. "Stress-testing banks for climate change – a comparison of practices." FSI Insights 34, Bank for International Settlements. https://www.bis.org/fsi/publ/insights34.pdf
European Central Bank (ECB). 2021. Climate risk stress test. Frankfurt am Main: European Central Bank. https://www.bankingsupervision.europa.eu/ecb/pub/pdf/ssm.climateriskstresstest2021~a4de107198.en.pdf?4e87d68b76928e0bb07adf23f39a1f47
European Central Bank (ECB). 2022. Macro-financial scenarios for the 2022 climate risk stress test. Frankfurt am Main: European Central Bank. https://www.bankingsupervision.europa.eu/ecb/pub/pdf/ssm.macrofinancialscenariosclimateriskstresstest2022~bcac934986.en.pdf
Mejstřík, Michal, Magda Pečená, and Petr Teplý. 2014. Bankovnictví v teorii a praxi = Banking in theory and practice. Prague: Karolinum.
OECD. 2021. Policy Highlights: Managing Climate Risks, Facing up to Losses and Damages. Paris: OECD Publishing. https://www.oecd.org/environment/cc/losses-and-damages/
Reinders, Henk Jan, Dirk Schoenmaker, and Mathijs van Dijk. 2020. A Finance Approach to Climate Stress Testing. http://dx.doi.org/10.2139/ssrn.3573107
Wee, Kenneth, Kirill Katsov, Chi Lai, and Zubin Mogul. 2021. Non-Financial Risks Reshape Banks’ Credit Portfolios. New York: BCG. https://www.bcg.com/publications/2021/managing-non-financial-risks-in-bank-credit-portfolios

Předběžná náplň práce v anglickém jazyce

Research question and motivation

This thesis aims to carry out a climate stress test of a Czech bank’s balance sheet over a 30-year horizon by focusing on the following asset classes: retail real estate, mining industry and electricity and energy supply sector. It should answer whether the proposed pathway to limiting global warming under 1.5 °C (a Net Zero 2050 scenario) implies lower loan losses compared to less strict climate policies and if accounting for a dynamic balance sheet mitigates bank losses in comparison with a static balance sheet.

Climate change is one of the largest non-financial risk exposures of banks. Global GDP losses stemming from altering climate are estimated to be 1–10% by the year 2050 compared to the constant climate situation, and up to 23% by 2100 (OECD 2021, 6). Wee et al. (2021, 1–4) report that 71% of surveyed credit portfolio managers already consider ESG issues in their decisions – the most out of all non-traditional banking risks – yet most of them struggle to translate the risks into quantitative variables suitable for stress testing models. Quantifying the impact of climate change on banks, one of the key financial intermediaries, is essential to understanding the potential effects on financial sector stability. A bankruptcy of a systemically important bank would yield severe consequences, particularly in the Czech bank-oriented financial system, in which banks act as principal risk offsetting agents (Mejstřík, Pečená, and Teplý 2014, 55), and stress tests are tools to detect the system’s instabilities and help prevent such events.

As an addition to the financial risk management framework, climate stress tests emerged in the last decade as a reaction to a greater acknowledgement of climate change among companies and governments. Pioneering academic papers, such as Batisson et al. (2017), focused mainly on the impacts of changing values of equities held by banks; the latest works have also included effects on credit portfolios, which in European countries constitute a significantly larger share of bank assets (Reinders, Schoenmaker, and van Dijk 2020, 2).

In the last five years, several central banks incorporated pilot climate stress tests into their regulatory frameworks (Baudino and Svoronos 2021, 1). Most notably, in the first half of 2022, the European Central Bank conducted an exercise that assessed climate data availability and preparedness of European banks for future testing, and in which selected banks were required to provide their estimates of climate change impacts on their asset portfolios. The exercise contained three parts: a questionnaire on banks’ testing resources, an analysis of banks’ business models and exposure to carbon-intensive industries, and a bottom-up stress test. The methodology of the latter was built on short- and long-term scenarios provided by the Network for Greening the Financial System (NGFS) which models both physical risks, such as droughts and floods, and transition risks arising from future climate policies (ECB 2021).

Czech supervisor, the Czech National Bank, has yet to introduce its climate-change-related measures. Nevertheless, local largest banks were required to participate in the ECB exercise as subsidiaries within European bank groups. In this thesis, I intend to take an existing climate risk management infrastructure within a European bank group and model impacts on three major asset classes of a Czech subsidiary with which I cooperate and for which the ECB test results are unknown. Knowledge of the individual scope of existing environmental risk will allow the bank to adapt its business strategy to specifically mitigate the risk arising from local conditions.


Contribution

The expected contribution of my thesis is twofold. First, it provides an overview of progress in climate stress testing and inspects in detail the ECB Climate Stress Test 2022 and its application within a European bank group. Second, it models how climate change affects portfolios of mortgages, mining industry exposures, and electricity and energy supply sector exposures in a large Czech bank. While the earlier summarizes existing research, the latter will be an addition to the growing literature about climate change and its effects on the financial system as it shall provide the first available estimates for Czechia. The results may enrich the bank’s existing risk management infrastructure and can be used as groundwork for further research in climate stress testing.


Methodology

First, I will define climate risks according to regulatory authorities (BCBS, ECB), briefly cover research conducted on the topic of climate stress testing and determine vulnerable asset classes. Second, a summary of the ECB climate stress test principles will be provided with its application in a bank group. The focus will be particularly on the long-term scenarios developed by NGFS that were used in the exercise – the Net Zero 2050, Delayed Transition, and Current Policies scenarios (ECB 2022). The quantitative section of my thesis will be built on portfolio and carbon footprint data provided by a Czech bank and on ECB climate scenarios data provided to banks; the latter is freely available online. My thesis will cover three asset classes: retail mortgages, the mining industry, and the electricity and energy supply sector.

In line with the ECB’s long-term transition risk stress test, my work will include developing a dynamic balance sheet capturing the bank’s business strategy and then estimating default probabilities (PD) with losses given default (LGD). The real estate will be divided into groups by energy performance certificates, and PDs and LGDs will be determined for each group from historical observations. Exposures in the mining and energy industries will be analysed individually using credit default models (see Reinders, Schoenmaker, and van Dijk (2020)). Furthermore, the same risks will be quantified for a static balance sheet to test the sensitivity of the stress test to the balance sheet structure.

Hypotheses:
1. Loan losses are the lowest in the orderly (Net Zero 2050) scenario for both static and dynamic balance sheets.
2. Loan losses for the dynamic balance sheet are projected to be lower than for the static balance sheet.


Outline

1. Introduction
1.1. Climate-related risks
1.2. Climate stress testing
1.3. Carbon footprint measurement and vulnerable industries
2. ECB Climate Stress Test and its implementation in a European bank group
2.1. Test principles
2.2. Long-term scenarios and dynamic balance sheets
2.3. Scenario translation into risk variables (PD, LGD)
3. Model
3.1. Retail mortgages
3.2. Mining industry
3.3. Electricity and energy supply industry
4. Conclusion