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Climate transition risk and the role of bank capital requirements

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  • Salomón García-Villegas

    (Banco de España)

  • Enric Martorell

    (Banco de España)

Abstract

How should bank capital requirements be set to deal with climate-related transition risks? We build a general equilibrium macro banking model where production requires fossil and low-carbon energy intermediate inputs, and the banking sector is subject to volatility risk linked to changes in energy prices. Introducing carbon taxes to reduce carbon emissions from fossil energy induces risk spillovers into the banking sector. Sectoral capital requirements can effectively address risks from energy-related exposures, benefiting household welfare and indirectly facilitating capital reallocation. Absent carbon taxes, implementing fossil penalizing capital requirements does not reduce emissions significantly and may threaten financial stability. During the transition, capital requirements can complement carbon tax policies, safeguarding financial stability and trading off long-run welfare gains against lower investment and credit supply in the short run.

Suggested Citation

  • Salomón García-Villegas & Enric Martorell, 2024. "Climate transition risk and the role of bank capital requirements," Working Papers 2410, Banco de España.
    • Handle: RePEc:bde:wpaper:2410
    DOI: https://doi.org/10.53479/36292
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    More about this item

    Keywords

    climate risk; financial intermediation; macroprudential policy; bank capital requirements;
    All these keywords.

    JEL classification:

    • Q43 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Energy and the Macroeconomy
    • D58 - Microeconomics - - General Equilibrium and Disequilibrium - - - Computable and Other Applied General Equilibrium Models
    • 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

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