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A “green supporting factor” is a policy proposal that aims to encourage banks to lend more to environmentally friendly projects by lowering the capital requirements for such loans. It assumes that green loans have lower risks than non-green loans and therefore deserve preferential treatment in banking regulation.
However, this idea is controversial and has been criticised on the grounds that it could distort the market and undermine financial stability. There are broadly two kinds of objections: one, unsurprisingly favoured by bankers and traders, appeals to market efficiency, the other, favoured by regulators, relies on the objective quality of risk assessment.
The first argument is that capital requirements adjusted for “greenness” would simply shift the funding of certain industries away from banks and towards other forms of financing. This would entail a somewhat higher cost of funding that will be fulfilled by institutions not subject to banking regulation. Consequently, the argument goes, the measure would distort the functioning of the market without having a real impact on the issue at hand (carbon-intensive businesses will still find access to finance, albeit at a marginally higher cost).
A corollary to this argument is that an appropriately high price for the right to emit carbon dioxide would instead give the correct incentive for the market to allocate capital in the most efficient way, by taking into account the social cost of carbon emissions.
This line of reasoning relies on two somewhat contradictory assumptions: that financial markets are indifferent to banking capital requirements and hence would find a way to finance carbon-intensive firms regardless of regulatory intervention, and that those same markets would instead react strongly to a different type of regulation, factoring in the presence of a carbon tax and presumably withdrawing funding from carbon-intensive firms in favour of greener ones.
While it is certainly the case that large companies who can access the financial markets directly would continue to do so, the likely higher cost of funding would have a negative impact, everything else being equal, on their carbon-intensive activities. Moreover, many companies, especially outside the US and of smaller size, rely on banking financing much more heavily and a green supporting factor would make a substantial difference.
On the other hand, while it is certainly the case that a carbon tax, conservatively estimated and universally applied, would be both a highly efficient tool to reduce overall emissions and the basis for a functioning market in carbon credits, it is far from evident that governments around the world have either the technical capabilities or the political will to implement it.
Although some level of carbon taxation has been in place for some time in several countries, only a very wide international agreement on the level of a carbon tax and on the way the related credits could be traded would be effective, as mobility of capital and regulatory/tax arbitrage would otherwise allow carbon-intensive businesses (especially the big ones who also have direct access to capital markets) to simply shift their operations to profit from more lenient regimes.
Furthermore, the level of carbon prices likely to support an orderly transition is likely to be much higher than current ones. The European Central Bank estimates “shadow” carbon prices for the Net Zero by 2050 climate scenario to rise from $200 in 2030 to $600 in 2050 (for reference, current levels across the world are nowhere near those numbers)....
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