Title
Can financial intermediation mitigate climate change?

CoPED ID
e78f21ab-85d8-4956-91e0-59236700ca2b

Status
Active

Funders

Value
No funds listed.

Start Date
Sept. 30, 2021

End Date
Sept. 29, 2025

Description

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1. Introduction
Climate change poses a major threat to the ecosystem, mankind and the world economy (Nordhaus, 2019). The 2015 Paris Agreement represents a global effort to "make finance flows compatible with a pathway toward low greenhouse gas emissions and climate-resilient development". The president of the ECB, Christine Lagarde (2021), has advocated that a low carbon society requires boosting "green finance". Governments, corporations, and households must all make adequate investments to promote a low carbon transition (Hong et al., 2020). Thus, governments are increasingly under pressure to reduce carbon emission and achieve carbon neutrality by 2050 to mitigate climate change. Financial institutions allocate significant funding to polluting companies. According to Rainforest Action Network (2019), since the Paris Agreement, the world's top banks have injected $1.9 trillion into fossil fuel companies. There is also evidence that price stability, which is the primary mandate of the central bank, could become affected by climate change (Schnabel, 2021). Hence, as part of their mandate, central banks should adopt policies, which mitigate climate change in line with the government.
The aim of this study is to use a theoretical and empirical frameworks to investigate how government policies could encourage firms to reduce carbon emission through the finance channel. Firms are profit maximizers. So, charging companies for the costs associated with the societal and environmental carbon pollution they cause, would disincentivize their high carbon emission (Lagarde, 2021). Banks' credit represents the main source of funding for firms (Campiglio, 2016). Thus, imposing higher financing costs to polluting as opposed to non-polluting firms should encourage lowering carbon emission. Within this scenario, it would be then the government responsibility to adopt policies which regulate banks financing of firms.
Using sequential game model, system dynamics model, and panel data method, this study investigates how government could reduce firms carbon emissions through financial intermediation.

2. Research Design
The sequential game model is widely used in supply chain management and energy system research to elucidate interactions among stakeholders with conflicting objectives (Tunca and Zhu, 2017; Liu et al., 2007; Dong and Rudi, 2004). Using a three-stage sequential game model, involving the government, the bank, and the individual firm, the study will generate theoretical solutions based on the different objectives and decision variables (Figure l).
Green tax and renewable energy subsidies will form the decision variables by the government. The government first sets the green tax t and renewable energy subsidy K under the objective of social welfare maximization. This green tax constitutes the direct cost for the polluting company. Both the carbon price imposed by the carbon trading scheme and the tax on the polluting fuels can be seen as a green tax. Renewable energy subsidy is used to promote the adoption of renewable energy technologies in sectors like electricity generation (Acemoglu et al., 2012; Popp, 2002).
Unanticipated changes policies could result in repricing of bank's asset value and cause significant loss (Batten et al., 2016; ESRB, 2016). Thus, the bank needs to take into account environmental policies in its decision-making process. In this model, following the government policy, the bank adjusts the interest rate r to the firm, based on the principle of profit maximization. Finally, the firm will take into account the government policy and financing cost as a constrain on its profit and decides on its carbon emission q and product price p under the principle of profit maximization.

Yener Altunbas SUPER_PER
Yi Ou STUDENT_PER

Subjects by relevance
  1. Emissions
  2. Climate changes
  3. Climate policy
  4. Carbon dioxide
  5. Energy policy
  6. Finance
  7. Greenhouse gases
  8. Decrease (active)
  9. Costs
  10. Renewable energy sources
  11. Enterprises
  12. Carbon
  13. Climate protection
  14. Banks (monetary institutions)

Extracted key phrases
  1. Firm carbon emission
  2. Climate change
  3. Unanticipated change policy
  4. Financial intermediation
  5. Low carbon society
  6. Low carbon transition
  7. Government policy
  8. Carbon price
  9. Environmental carbon pollution
  10. Carbon trading scheme
  11. Low greenhouse gas emission
  12. Carbon neutrality
  13. Financial institution
  14. Renewable energy subsidy K
  15. Government responsibility

Related Pages

UKRI project entry

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