11. Role of Bank Lending in Financing Green Projects

This chapter develops an environmental dynamic stochastic general equilibrium (E-DSGE) model with heterogeneous production sectors. In particular, the model specifies for the inclusion of low-carbon emissions firms that finance their investments and production only through banking loans, and high-carbon emissions firms that finance their investments either with bank loans or by issuing equities. Moreover, governments impose intensity targets to reduce pollution and allow high-carbon emissions firms to buy permits to allow their production. The model studies the transmission mechanism of technology, monetary, and financial shocks and finds that only a positive financial shock to green firms can boost production and credit. Financial shocks can be interpreted as those that affect the borrowing capacity of firms by tightening or relaxing the enforcement of collateral constraints. By contrast, a positive technology shock and easier monetary policy lead only to a short output on impact; over the longer term, green firms experience losses. The chapter analyzes the impact of several macroprudential policies and finds that only differentiated capital requirements can sustain green financing.