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

Author

Listed:
  • Grill, Michael
  • Popescu, Alexandra
  • Rancoita, Elena

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

Suggested Citation

  • Grill, Michael & Popescu, Alexandra & Rancoita, Elena, 2024. "Climate transition risk in the banking sector: what can prudential regulation do?," Working Paper Series 2910, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20242910
    Note: 1280809
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    References listed on IDEAS

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    Cited by:

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    More about this item

    Keywords

    prudential regulation; transition risk; financial frictions;
    All these keywords.

    JEL classification:

    • D58 - Microeconomics - - General Equilibrium and Disequilibrium - - - Computable and Other Applied General Equilibrium Models
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming

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