The green trilemma in consumer credit: How ESG integration buffers mortgage portfolios against climate and interest rate shocks

Abstract

This research explores the relationship among retail banks' Environmental, Social, and Governance (ESG) metrics, localized climate events, and the credit risk associated with residential mortgages. Specifically, it examines the "Green Trilemma" in consumer lending, which underscores the tension banks experience when trying to expand credit availability (Social), ensure financial stability (Governance), and control climate-related exposures (Environmental). Utilizing a dual-shock conceptual model, the study assesses severe physical climate occurrences and abrupt monetary tightening, namely, interest rate spikes on adjustable-rate mortgages (ARMs) that act as key drivers of household financial hardship. By integrating a proposed panel dataset of bank mortgage portfolios with detailed geospatial climate risk metrics and macroeconomic interest rate data, the research investigates if retail banks with strong ESG profiles see reduced mortgage defaults amid these compounding pressures. The central hypothesis posits that robust ESG integration buffers against consumer default via two mechanisms: pre-emptive risk screening (the "Green Underwriting" effect) and proactive borrower assistance following a shock (the "Social Nudge" effect). Ultimately, the anticipated results aim to deliver micro-level empirical proof that embedding ESG standards into retail lending serves as a versatile defense against both physical and economic shocks, thereby advancing Sustainable Development Goals such as SDG 1 (No Poverty), SDG 11 (Sustainable Cities), and SDG 13 (Climate Action).