Climate Risk Strategies for RMBS
Residential Mortgage-Backed Securities (RMBS), supported by residential mortgages, are exposed to physical climate risks such as floods, cyclones, and bushfires, which have been exacerbated by climate change.
While these risks can impact property values and borrowers' ability to repay loans, there are positive factors to consider. Mortgage insurance and structural features of RMBS offer protection, while the RBA's indirect exposure to RMBS is managed through stringent criteria like maintaining AAA ratings and applying margins to collateral values. This analysis builds on previous research to evaluate climate risks in RMBS eligible as collateral for the RBA, focusing on concentrated risks within mortgage pools and extending analysis to non-bank lenders relying on RMBS funding.
As of December 31, 2023, the average Value of Risk (VaR) index was slightly below the national average, indicating a degree of resilience. Although small banks exhibited more variation, overall risk levels were manageable. Even in the riskiest RMBS, the VaR index, while higher, remained stable in its ranking compared to the national average.
Similarly, while the proportion of high-risk properties was slightly below the national average, the analysis provides insights into potential shifts by 2050. Despite anticipated increases, the ranking stability of RMBS by VaR suggests a degree of predictability in risk management strategies.
The projection for 2050 under a high emissions scenario presents challenges but also opportunities. While an increase in VaR and high-risk properties is expected, RMBS structures demonstrate resilience. Furthermore, the potential impact on borrower leverage, while noteworthy, is mitigated by existing safeguards like lenders' mortgage insurance.
Despite the optimism, it's crucial to acknowledge limitations in the analysis. Overestimations and underestimations of climate risk are possible due to various factors, including the exclusion of land values in VaR calculations and privacy considerations in assigning climate risk based on postcode averages.
Moreover, uncertainty remains regarding the likelihood and impacts of specific climate scenarios, highlighting the need for ongoing research and adaptation strategies. By recognizing these limitations and continuing to explore innovative metrics for quantifying climate risks, the financial sector can better navigate the challenges and opportunities presented by climate change.
Source: https://www.rba.gov.au/publications/bulletin/2024/apr/assessing-physical-climate-risk-in-repo-eligible-residential-mortgage-backed-securities.html