Euro Area Banks' Sensitivity to Changes in Carbon Price
43 Pages Posted: 12 Mar 2022
Date Written: March, 2022
In recent years there has been growing attention on the risks posed by climate change. One relevant question for ﬁnancial stability is to which extent the materialisation of transition risks emerging from the sudden implementation of climate change mitigation policies would impact the ﬁnancial system. In this paper we analyze the eﬀects of changes in carbon price on the European banking system. We assess this climate change transition risk through a banking sector contagion model where ﬁrms are negatively impacted by an increase in carbon prices. Using a unique granular dataset we evaluate the consequences of a combination of diﬀerent increases in carbon prices and ﬁrm emission reduction strategies. We ﬁnd that taking early policy action, implying more gradual changes in carbon prices, is not expected to lead to adverse impacts on the banking system, especially if ﬁrms reduce their emissions eﬃciently. Conversely, a disorderly, abrupt transition to a low carbon economy requiring very high sudden changes in carbon prices might have disruptive eﬀects on the ﬁnancial system, especially if ﬁrms fail to reduce their emissions.
Keywords: climate change, empirical banking, financial networks, transition risk
JEL Classification: Q48, Q54, Q58
Suggested Citation: Suggested Citation