Do energy efficiency improvements (retrofit) to existing homes in your mortgage book reduce your capital requirements as a lender?
Well, in theory: yes they do.
In this article we’ll break down how energy efficiency improvements can reduce capital requirements – and how this fits into current capital requirements legislation in the UK.
How can energy efficiency improvements reduce capital requirements?
Let’s start with a quick reminder of the basics on capital requirements for lenders.
The Loan-to-Value (LTV) ratio is, of course, crucial for determining capital requirements.
The LTV ratio states the ratio between the asset value (in this case a home) and the amount the lender finances (in this case as a mortgage loan).

The higher the LTV ratio, the riskier the loan is for the mortgage lender – you’re lending a high proportion of the property’s value, so if the loan defaults there’s a higher chance that you wouldn’t be able to recoup the losses by selling the asset.
This is factored in when calculating capital ratios (i.e. comparing your capital to your risk-weighted assets) because the more risk exposure a loan has, the higher the risk weight that asset receives.

The more high risk-weighted assets a lender has, the higher the amount of capital they must hold in order to meet regulatory minimum capital adequacy requirements (Pillar 1) – which are focused on the ratio between liquid capital and assets.
And that’s where energy efficiency comes in – because retrofit improvements can be a very effective way to lower the risk-weighting of assets in a mortgage portfolio.
Upgrading a home’s energy efficiency has a positive impact on the valuation of the home.
There are lots of studies suggesting this could be the case, ranging from BOXT who found a 23% increase in valuation from retrofitting to Nationwide who found a much smaller increase of 1.7%.
Our analysis finds that the average valuation uplift from retrofit improvements across these existing studies is 12.5%. These studies are indicative rather than conclusive of the link between energy efficiency and property value, but an average of 12.5% leaves ample room for error whilst still indicating an impactful link.

An increased property value means a lowered LTV – the outstanding amount left to be repaid on the mortgage is now lower compared to the value of the asset.
Let’s look at a worked example to fully illustrate the point:
- A home rated an EPC E is bought at an LTV of 80% – a mortgage of £200,000 to be repaid against a property valued at £250,000
- The homeowner makes energy efficiency improvements that bump it up to an EPC B rating
- The property value increases by 12.5% due to the higher energy efficiency – meaning the asset is now valued at £281,250
- In the meantime, the homeowner has also paid off £20,000 of the mortgage, so the outstanding mortgage is £180,000
- Therefore, the LTV has now reduced to 64% – £180,000 / £281,250 x 100.
The lowered LTV means this asset now has a lower risk weighting for capital requirements calculations, which means the lender needs to hold less capital against risks and has more capital for lending.

This brings huge incentive for mortgage lenders to encourage their existing customers to retrofit their home.
Plus, alongside this, energy efficient homes also carry lower risk of arrears and defaulting – another key factor for mortgage lenders when calculating capital requirements.
Why is this the case?
Well, with energy bills sky high and very volatile, energy costs and performance make a big difference to a homeowner’s affordability for mortgage repayments – the more energy efficient a home, the lower the energy bills, the lower the risk of arrears.
So, is this reflected in current legislation on capital requirements?
Is energy efficiency included in regulatory capital requirements calculations for mortgage lenders?
When it comes to capital requirements, climate risks are currently included in two ways:
- Implicitly in the Pillar 1 capital framework (i.e. minimum capital requirements) for mortgage lenders through the role of LTVs in determining risk – as we’ve explored.
- Explicitly in Pillar 2 obligations i.e. the ICAAP (Internal Capital Adequacy Assessment Process) which must include identifying and measuring climate risks as well as stress testing and scenario analysis on those climate risks – as made clear in the PRA’s 2022 ‘Dear CEO’ letter on climate-related financial risks.
“Banks are expected to be able to explain how they are comfortable that any material climate risks are appropriately capitalised for. In particular, climate risks that are not adequately captured within the existing Pillar 1 framework should be considered by banks in their ICAAPs under Pillar 2.”
Bank of England Report
Despite these existing obligations, the Bank of England feels there are significant blind spots when it comes to climate risk and capital frameworks.
In their 2023 report, which covers their latest thinking on climate-related risks and regulatory capital frameworks, they highlight that gaps remain which leave a high level of uncertainty on whether financial institutions are holding enough capital to account for climate risks.

The gaps they highlight are:
- Capability gaps i.e. the ability of financial institutions to accurately identify and measure climate risks – we all know the struggles with EPC data for mortgage books, for one!
- Regime gaps i.e. the effectiveness of current capital framework methodologies to properly account for climate risk – for instance, climate risks tend to require much longer-term planning but current capital frameworks have limited time horizons.
“Existing capability and regime gaps create uncertainty over whether banks and insurers are sufficiently capitalised for future climate-related losses.”
Bank of England report
Interestingly, the Bank of England also published a research paper with Nationwide in 2022 where they explored what the impact would be if energy efficiency ratings (i.e. EPC rating) and the associated default risk were reflected in capital requirements.

The findings were pretty telling.
For Nationwide’s mortgage book, customers with high or medium energy efficiency properties were found to be around 20% less likely to default than customers with low energy efficiency properties – with several statistical significant and robustness tests included in the methodology to check the accuracy of this finding.

If this was reflected in capital calculations then Nationwide would be able to hold 12.44% less capital for its portfolio of A rated properties.
And if Nationwide then shifted its portfolio to include more high energy efficiency properties (via driving customer retrofits) it would lead to a reduction in overall capital requirements.
It certainly seems like the Bank of England is clear that this area needs further policy work, and is actively exploring options for better reflecting the relationship between energy efficiency and risk within capital requirements calculations.
This theme has also been explored in legislation elsewhere, so it’s clearly a popular topic.
One example is the EU exploring the idea of a ‘green supporting factor’ through the Energy Efficient Mortgages project – essentially giving a lower rate of capital requirement to banks with a high amount of low risk green assets.
A green supporting factor has already been adopted by the Hungary Central Bank, where banks are eligible for a capital requirements discount if they apply at least a 0.3% interest rate reduction for green loans. This resulted in €2.4 billion euros worth of green loans being raised in 2023 – an increase of 75% before the green supporting factor was introduced.
On the other hand, several organisations (such as Moody’s) have highlighted that a green supporting factor could weaken risk assessments and capital requirements by leading to other risks being underestimated.
So it may be that the green supporting factor is not the way legislation ends up leaning – but it’s evident that explorations are ongoing across the globe.
For now, we’ve seen that the link between energy efficiency, increased property valuation, and decreased risk of arrears absolutely does already impact the availability of capital for lenders through the impact on LTVs and internal risk management processes.
So, even if it isn’t explicitly included in capital requirements legislation just yet, there’s still huge capital incentive for mortgage lenders to include driving the uptake of customer retrofits in their list of top priorities.