Seite - 7 - in options, Band summer 2021

POLICY FIRM SECT OR BAN K IN G SECT OR CARBON T AX BROW N G OOD PRICE IN T EREST RAT ESD EM AN D CASCAD IN G EFFECT S Disposable Income E mployment G DP B rown capital good G reen capital good PROFIT S N ON - PERFORM IN G LOAN S CAPIT AL AD EQ UACY RAT IO News in brief Banks’ climate sentiments, that is, their expectations and pricing of climate-financial risks – and especially of climate transition risks – can foster or hinder an orderly low-carbon transition. Nevertheless, they have been neglected by macroeconomic and financial risk analysis so far. IIASA researchers and colleagues at the Vienna University of Economics and Business (WU) assessed the impact of banks’ climate sentiments on climate policy effectiveness, considering two types of climate policies: a carbon tax and a green supporting factor. They considered under which conditions a carbon tax or green supporting factor could foster green capital investments to achieve the EU2030 targets, and the implications for banks’ financial instability, focusing on loan contracts. “Depending on the timing and implementation, a simple carbon tax can reduce the profitability of high- carbon firms, leading to non-performing loans which could, in turn, pose credit-risk for banks. To maintain regulatory capital, banks increase the cost of credit for high-carbon firms, leading to a credit crunch that would also affect green firms negatively, thus putting the success of an orderly low-carbon transition at risk,” explains Irene Monasterolo, a researcher at WU. “In contrast, banks’ anticipation of the impact of the carbon tax on high carbon firms would lead to smooth adjustments of prices and greening of the economy.” To analyze the macro-financial implications of a carbon tax and a green supporting factor, and the feedbacks effects from banks’ climate sentiments, the researchers developed a stock-flow consistent model that embeds a forward-looking approach to the pricing of climate risks in banks' lending contracts and credit risk born by firms, departing from rational expectations. “We found that a carbon tax would put a cost on carbon-intense production thus making low-carbon production and investment in such production facilities more attractive. To prevent unintended effects, a carbon tax should however be complemented with distributive welfare measures,” says IIASA researcher Asjad Naqvi. “A green supporting factor on the other hand, would lower the capital requirements for loans that banks give out for green investments, thus making green lending for banks more attractive and potentially resulting in better credit conditions for green investment projects,” adds Nepomuk Dunz, an alumnus of the IIASA Young Scientists Summer Program (YSSP) currently affiliated with WU. According to the researchers, policy credibility is crucial to building trust in the banking sector, whose climate sentiments, in turn, help with successful policy implementation and minimize the negative impacts on economic and financial instability. Stock flow consistent models can help central banks and financial regulators to identify the relation between climate transition risk and financial instability and identify suites of policies (fiscal, monetary, and macroprudential) to foster banks’ pricing of climate risks in their lending. The article is part of the special issue on Climate Risks and Financial Stability published in the Journal of Financial Stability (2021). Investing in a low-carbon future Asjad Naqvi: naqvi@iiasa.ac.at Further info: pure.iiasa.ac.at/17153 The financial sector is expected to play a key role in achieving a greener future, but how will climate policies and banks’ pricing of climate-related risks influence an orderly transition to a low-carbon economy? 7Optionswww.iiasa.ac.at Summer 2021