Green Capital Requirements

Résumé

We study bank capital requirements as a tool to address financial risks and externalities caused by carbon emissions. Capital regulation can effectively address financial risks but doing so does not necessarily reduce emissions (e.g., higher capital requirements for carbon-intensive loans may crowd out clean lending). Relative to a planner who also has access to a carbon tax, reducing emissions via capital requirements alone may require sacrificing financial stability or may be altogether infeasible. However, if the government cannot commit to future environmental policies, capital requirements can make carbon taxes credible by ensuring banks have sufficient capital to absorb losses from stranded asset risk.

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