Climate transition risk in the banking sector: what can prudential regulation do?

Michael Grill, Alexandra Popescu and Elena Rancoita

No 2910, Working Paper Series from European Central Bank

Abstract: Climate-related risks are due to increase in coming years and can pose serious threats to financial stability. This paper, by means of a DSGE model including heterogeneous firms and banks, financial frictions and prudential regulation, first shows the need of climate-related capital requirements in the existing prudential framework. Indeed, we find that without specific climate prudential policies, transition risk can generate excessive risk-taking by banks, which in turn increases the volatility of lending and output. We further show that relying on microprudential regulation alone would not be enough to account for the systemic dimension of transition risk. Implementing macroprudential policies in addition to microprudential regulation, leads to a Pareto improvement. JEL Classification: D58, E58, E61, Q54

Keywords: prudential regulation; transition risk; financial frictions (search for similar items in EconPapers)
Date: 2024-02
New Economics Papers: this item is included in nep-ban, nep-dge, nep-env, nep-fdg and nep-rmg
Note: 1280809
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20242910

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