Shadow banking and consistency of a carbon-intensive Counter-Cyclical Capital Buffers regulation

This paper examines whether a Counter-Cyclical Buffer (CCyB) indexed to carbon-intensive credits, i.e., a carbon-intensive CCyB, is consistent with the banking stability objectives of financial regulators when unregulated banks operate in credit markets. To do so, we assess the consistency of the carbon-intensive CCyB regulation through the lens of a general equilibrium model that encompasses polluting and non-polluting firms (i.e., green and brown firms, respectively), as well as traditional and shadow banks (i.e., regulated and unregulated banks, respectively). We find that a carbon-intensive CCyB regulation is not the most suitable for financial regulators when there are no asymmetric leakages between green and brown loans for traditional and shadow banks. However, a strict emissions tax applied to the production of brown firms favors the adoption of a carbon-intensive CCyB regulation by financial regulators. Moreover, a carbon-intensive CCyB could be suitable when traditional banks are more involved in the green credit market than in the brown one. This last result highlights the need for regulators to carefully coordinate their green policies to avoid jeopardizing the stability of the banking system.