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Should new prudential regulation discriminate green credit risk ? A macrofinancial study for the Output Floor case

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  • Corentin Roussel

Abstract

Differentiated treatment of green credit risk in banks’ capital requirements to favor green transition generates lot of debates among European prudential regulators. The aim of this paper is to examine whether the key Basel 3 finalization instrument - the Output Floor - should be applied to green credit risk in order to ensure stability of banking system and promote green finance. To do so, we assess macrofinancial and environmental benefits of such green policy for the Euro Area through the lens of a general equilibrium model. We get three main results. First, when banks get transitory ’environmental awareness’, an Output Floor (OF) applied to brown credits only (i.e. a brown OF) faces a trade-off between limiting environmental aftermaths and reaching OF objectives (i.e reducing volatility of banks’ capital adequacy ratio). Second, to mitigate the prudential cost of this trade-off, brown OF should be joined with additional green financial policies such as green Quantitative Easing. Third, pollutant emissions tax erodes brown OF efficiency along financial and economic cycles but limits the welfare cost implied by pollution in the long run.

Suggested Citation

  • Corentin Roussel, 2024. "Should new prudential regulation discriminate green credit risk ? A macrofinancial study for the Output Floor case," Working Papers of BETA 2024-07, Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg.
    • Handle: RePEc:ulp:sbbeta:2024-07
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    References listed on IDEAS

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    1. Neisen, Martin & Schulte-Mattler, Hermann, 2021. "Eliminating the negative impacts of the Basel IV output floor by adjusting a bank’s business model," Journal of Risk Management in Financial Institutions, Henry Stewart Publications, vol. 14(3), pages 256-267, June.
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    6. Budnik, Katarzyna & Dimitrov, Ivan & Groß, Johannes & Lampe, Max & Volk, Matjaz, 2021. "Macroeconomic impact of Basel III finalisation on the euro area," Macroprudential Bulletin, European Central Bank, vol. 14.
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    More about this item

    Keywords

    Output Floor; Credit Risk; Green Finance; Climate Change; DSGE.;
    All these keywords.

    JEL classification:

    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers

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