How can green differentiated capital requirements affect climate risks? A dynamic macrofinancial analysis

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See all articles by Yannis Dafermos

Yannis Dafermos

SOAS University of London

Maria Nikolaidi

University of Greenwich

Date Written: July 22, 2020

Abstract

Using an ecological macrofinancial model, we explore the potential impact of the ‘green supporting factor’ (GSF) and the ‘dirty penalising factor’ (DPF) on climate-related financial risks. We identify the transmission channels by which these green differentiated capital requirements (GDCRs) can affect credit provision and loan spreads, and we analyse these channels within a dynamic framework in which climate and macrofinancial feedback effects play a key role. Our main findings are as follows. First, GDCRs can reduce the pace of global warming and decrease thereby the physical financial risks. This reduction is quantitatively small, but is enhanced when GSF and DPF are implemented simultaneously or in combination with green fiscal policies. Second, DPF increases the capital of banks and reduces their credit provision, making them less fragile. Third, both DPF and GSF generate some transition risks: GSF increases bank leverage because it boosts green credit and DPF increases loan defaults since it reduces economic activity. These effects are small in quantitative terms and are attenuated when there is a simultaneous implementation of DPF and GSF. Fourth, fiscal policies that boost green investment amplify the transition risks of GSF and reduce the transition risks of DPF; the combination of green fiscal policy with DPF is thereby a potentially effective climate policy mix from a financially stability point of view.

Keywords: stock-flow consistent modelling, climate change, financial stability, green financial regulation

JEL Classification: E12, E44, E52, Q54

Suggested Citation

Dafermos, Yannis and Nikolaidi, Maria, How can green differentiated capital requirements affect climate risks? A dynamic macrofinancial analysis (July 22, 2020). Available at SSRN: https://ssrn.com/abstract=

Yannis Dafermos (Contact Author)

SOAS University of London ( email )

Thornhaugh Street
Russell Square
London, WC1H 0XG
United Kingdom

Maria Nikolaidi

University of Greenwich ( email )

30 Park Row
Greenwich
London, SE10 9LS
United Kingdom

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