Summary:
Climate risk may become an important trigger of systemic financial risk. Therefore, central banks are devoting increasing attention to combating climate risks to maintain macro-financial stability. From a global perspective, theoretical guidance based on in-depth investigations is urgently required to enable regulatory practitioners to incorporate climate risks into the financial regulation framework and improve regulators' ability to address climate transition risks. With the strengthening of climate policies and the promotion of a green economic transition, the following key questions arise: How will the climate transition risks of Chinese banks change？ Can the macro-prudential regulatory framework address climate transition risks？ What innovations are required to enhance the ability of macro-prudential tools to cope with climate transition risks？ An in-depth study to answer these questions is of great practical significance for preventing and resolving major financial risks and ensuring macro-financial stability in China. Combining theoretical modeling and empirical testing methods, this paper analyses the impact of climate policy on bank risks, the effectiveness of macro-prudential policy in addressing climate transition risks, and new macro-prudential regulatory methods. First, based on the implementation of climate policies in China, we adopt a text data analysis to construct a Chinese climate policy strength index, and conduct empirical analyses based on the micro data of 320 commercial banks for the period from 2007 to 2021 to provide evidence on whether Chinese banks are facing climate transition risks, whether macro-prudential policy can effectively address such risks, and the influencing path of green credit bubbles. Second, we construct a bank risk-taking benchmark model to analyze the mechanism of climate transition risk generation and reveal the mechanism through which macro-prudential policy addresses climate transition risks. Finally, we extend the benchmark theoretical model and use simulation methods to study the effectiveness of increasing the “brown penalty factor” or decreasing the “green support factor” in addressing climate transition risks, and discuss a new macro-prudential regulatory method that dynamically fine-tunes both types of factors simultaneously. The main conclusions of this paper are as follows. (1) Strong climate policy may significantly increase bank risks and lead banks to bear increasing climate transition risks, with green credit bubbles being an important influencing path. (2) Strengthening macro-prudential policy to reduce banks' climate transition risks not only is difficult but also may amplify climate transition risks by encouraging the formation and collapse of green credit bubbles. (3) The dynamic macro-prudential regulatory method—that is, gradually increasing the “brown penalty factor” and decreasing the “green support factor”—can encourage banks to increase green loans while reducing climate transition risks. We put forward three policy recommendations for regulatory authorities to address climate risks. (1) Climate policy should be carried out gradually to promote the green economic transition while minimizing the adverse impact of climate transition risks on macro-financial stability. (2) Regulatory authorities should incorporate climate factors into the macro-prudential regulatory framework and improve macro-prudential tools. (3) A dynamic macro-prudential regulatory method that gradually increases the “brown penalty factor” and decreases the “green support factor” simultaneously should be adopted to address climate transition risks. This paper makes the following academic contributions. (1) We adopt the text data analysis method to construct a Chinese climate policy strength index. We thus examine the important empirical facts that, first, the Chinese banking sector is facing climate transition risks, and second, it is difficult for the existing macro-prudential regulatory framework to address these risks effectively, and identify the influencing path of green credit bubbles. (2) We construct a bank risk-taking model by incorporating climate policy and new macro-prudential tools, reveal the mechanism of climate transition risk generation, and analyze the effectiveness of existing macro-prudential regulation in addressing climate transition risks. (3) We propose a new macro-prudential regulatory method that involves gradually adjusting the “brown penalty factor” and the “green support factor” simultaneously to effectively address climate transition risks, providing important policy references for regulatory authorities to improve the macro-prudential regulatory framework and enhance China's ability to address climate-related risks.
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