Green Capital Requirements

Abstract

We provide a framework to study the effects of green capital requirements that give preferential capital treatment to clean loans. Our model embeds externalities into a model of bank capital regulation, so that regulation serves a dual purpose consisting of a prudential objective and an impact objective. The model clarifies the differential effects of green supporting and brown penalizing factors and highlights the potential for unintended consequences. For example, an increase in capital requirements for dirty loans may, in fact, crowd out clean lending. Finally, we show that, in the presence of climate risk, even a purely prudential regulator sets green capital requirements.