Last week marked Green GB Week, and both the PRA and FCA issued papers challenging financial institutions to consider how climate change may impact their business. In light of this, we thought it was the perfect opportunity to blog about green mortgages.

While some smaller firms have had green mortgages for a while they have only been launched as a mainstream product in the UK within the past 12 months. The idea behind them is that consumers taking out financing for an energy-efficient property can benefit from a cheaper rate on their mortgage. When you consider that mortgages are a commonly held financial product, this could be a simple way to get consumers on board with green investment.

Why would this appeal to lenders? Some research, including a recently piece of analysis published on the Bank of England's Bank Underground blog, suggests that the energy efficiency of a property may be a relevant predictor of whether or not the borrower will go into arrears. However, correlation is not the same as causation, and not all are convinced by the Bank's argument.

More significantly however, the idea of green mortgages appeals to governments that may be considering how to meet their commitments to mitigating climate change.

In 2015, EU member states made a binding commitment to reduce carbon emissions by 40 per cent of 1990 levels by the year 2030. An additional 40 per cent reduction from 1990 levels is planned by the year 2050. Across the bloc, buildings account for about 40 per cent of energy consumption, with the UK more or less in line with this average.  A widespread programme of retrofitting the existing stock of buildings could reduce the EU's energy consumption by an estimated five per cent.

While this sounds like a commendable incentive to financial innovation, we still think it is worth unpacking the link between energy efficiency and the risk associated with a mortgage.

It is thought that there are two potential avenues which could explain why a mortgage on an energy-efficient home might be less risky. Firstly, by making a property more energy efficient, the value of the property may increase, and this would feed through into an improved balance sheet position for the lender.

However, we are not fully convinced that the link is as simple as this. Property value is affected by the complex interaction of a range of factors of which energy performance is only one.

Secondly, a household with an energy efficient property will have, in theory, lower energy expenditures and therefore additional disposable income. This could provide a financial buffer for the household, reducing the likelihood of mortgage arrears.

However, despite several studies having established a correlation between energy efficient mortgages and performance of the asset, it is not fully clear whether this has anything inherent to do with energy efficiency, or if other unobserved factors are at play. For example, it is possible that consumers that purchase eco-friendly properties may be more conscientious than the average consumer, which may motivate both their preferences for green products and their financial behaviours.

Alternatively, there could be a socioeconomic explanation behind the link. In the UK, new-build energy efficient properties are more likely to be built in the south-east where, unsurprisingly given the strength of the local economy, arrears rates are very low. It is worth noting that ?energy efficient? is not a standardised term, so lenders will typically have specific requirements which a property needs to meet to qualify for a green mortgage.

The idea of a green mortgage is still a relatively new one, and it will take several more years of observation and an increased availability of data on energy efficiency, loan performance and perceived customer value to provide a more statistically robust explanation of the underlying linkage. However this plays out, green mortgages will undoubtedly be an area to watch going forward.