Benjamin Guin, Mahmoud Fatouh and Haluk Unal
Regulation has been asserted to be a brake on innovation. Prudential rules impose capital, liquidity and disclosure requirements, as well as stress tests, to strengthen resilience and manage risks – though some view them as potentially limiting financial innovation. Yet recent evidence from the UK mortgage market suggests the opposite: regulation can sometimes catalyse innovation, not suppress it.
Rethinking product innovation
Product innovation in banking is typically defined as the development and introduction of new financial instruments, services, or contractual features that expand the choices available to customers. In other words, it isn’t just about tweaking existing contracts – it’s about broadening the baseline product menu. The UK mortgage market is particularly well-suited for analysing product innovation, thanks to its clear and stable definitions of baseline products and transparent pricing structures. This allows us to systematically detect when new features are introduced and begin to influence pricing, revealing how lenders adapt their offerings in response to both market developments and policy signals.
Regulatory pressure as a catalyst
One such signal was the introduction of the Minimum Energy Efficiency Standards (MEES) in 2018, which targeted properties with low energy efficiency ratings, measured by Energy Performance Certificates (EPCs). The MEES did more than impose compliance requirements on landlords; it signalled a shift in the risk landscape for banks, as poor energy ratings became a risk factor for property values and mortgage collateral. Although MEES did not regulate banks directly, our estimates show a meaningful green discount in the pricing of such loans emerging around 2018. Lenders thus anticipated the MEES impact and adjusted pricing as shown in Chart 1 – a proactive response rather than box-ticking. In line with our framework, this adjustment in pricing points to product innovation, as financial institutions responded to regulatory signals by developing differentiated loan products and incentives that reflect energy performance. This discount became even more pronounced after the 2022 energy price shock, when energy efficiency moved from a policy priority to a financial necessity.
Chart 1: Timing of green mortgage discount
Notes: The chart shows how the pricing discount for energy‑efficient properties evolved over time. Each point reflects the estimated effect of a green rating on mortgage spreads relative to similar non‑green loans, with 95% confidence intervals.
Banks did not respond uniformly in the innovation period post-2018. Systemic banks – designated as domestically systemic (D-SIB) or globally systemic (G-SIB) by the UK PRA or by foreign regulators based on size, interconnectedness, and substitutability – were at the forefront of innovation. Chart 2 illustrates this heterogeneity. Bar (1), in navy, shows the main effect post-2018: on average, energy-efficient properties receive a significant green discount on mortgage spreads. Bars (2) to (4), illustrate the effects by bank category relative to the effect of other banks. Bar (2) shows that listed banks offered an additional discount compared to non-listed banks, suggesting investor scrutiny matters. Bar (3) shows systemic banks – including those under regulatory climate stress testing – also applied a further discount relative to non-systemic. Bar (4) is close to zero, meaning listed but non-systemic banks did not offer an extra discount over non-listed and listed and systemic banks. Overall, regulatory scrutiny – for example through C-BES – appears central to shaping green product offerings.
Chart 2: Mortgage pricing: bank heterogeneity (post-2018)
This idea of regulatory pressure is consistent with two alternative underlying economic mechanisms: banks may innovate to signal strong risk governance to investors and supervisors, demonstrating proactive management of emerging risks; or banks may seek to minimise future compliance costs by embedding new criteria into products early, pre-empting regulatory burdens. In both cases, regulatory pressure acts not just as a constraint, but as a catalyst for new product development – as seen in the rise of green mortgages.
Innovation and economic growth
The emergence of green mortgages shows how banks can respond to emerging risks by expanding their product menus. As energy efficiency became a salient policy priority, lenders began offering mortgages with discounted rates for homes meeting higher standards, embedding this criterion into pricing. Chart 3 shows that green mortgages are predominantly associated with new buildings: around 68% of mortgages for properties with green characteristics are for new builds, compared to just 3% for properties without green characteristics. This suggests that green mortgage products have primarily supported buyers of newly constructed, energy-efficient homes. By improving access to finance for these properties, green mortgages may have contributed to increased demand for new, energy-efficient housing and, indirectly, to construction activity. While the broader economic impact requires further study, this pattern illustrates how regulatory-driven innovation can influence markets beyond the financial sector.
Chart 3: Share of new buildings by EPC
A broader lesson
Green mortgage products are just one example. The same dynamic can apply to other risks – cyber, operational, or liquidity. When regulation highlights a new risk, banks may respond not just by tightening controls, but by designing new products that address it directly.
If regulation can drive product innovation, the implications are significant. Supervisors and policymakers might see such innovation as a sign of healthy adaptation. Monitoring the emergence of new products can offer early insights into how markets internalise new risks – and how policy can shape real economic outcomes.
In short: regulation and innovation aren’t always at odds. Sometimes, it’s the catalyst that gets banks thinking differently about risk – and about the products they offer.
Benjamin Guin works in the Bank’s Strategy and Policy Approach Division, Mahmoud Fatouh works in the Bank’s Prudential Framework Division and Haluk Unal works at the University of Maryland.
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