CAROs: Climate Risk-Adjusted Refinancing Operations

Florian B\¨oser () and Chiara Colesanti Senni ()
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Florian B\¨oser: CER–ETH – Center of Economic Research at ETH Zurich, Switzerland
Authors registered in the RePEc Author Service: Florian Böser

No 21/354, CER-ETH Economics working paper series from CER-ETH - Center of Economic Research (CER-ETH) at ETH Zurich

Abstract: Policy makers have argued that markets are not pricing climate risk appropriately yet, which may lead to a misallocation of resources and financial instability. Climate risk-adjusted refinancing operations (CAROs) conducted by the central bank are one possible instrument to address this issue. CAROs are characterized by interest rates on reserve loans, which depend on the climate risk exposure of the assets held by the borrowing bank. If private agents and the central bank have differing beliefs about the likelihood of the transition to a low-carbon economy, the allocation emerging without CAROs is, from the central bank’s perspective, suboptimal and may lead to financial instability. We find that an appropriate design of CAROs allows the central bank to influence bank lending in a way that induces the optimal allocation under its beliefs and eliminates financial instability. Moreover, we show that investment into climate risk mitigation reduces the need for central bank intervention, and that CAROs can be used to achieve specific climate-related allocation targets.

Keywords: central bank; banks; refinancing operations; interest rates; climate risk (search for similar items in EconPapers)
JEL-codes: D84 E42 E43 E44 E58 G21 Q50 (search for similar items in EconPapers)
Pages: 60 pages
Date: 2021-05
New Economics Papers: this item is included in nep-cba, nep-env and nep-mac
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Citations: View citations in EconPapers (1)

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