Impact of low-carbon monetary policies on climate-related systemic risk: Evidence from China

Abstract

The issue of using green finance policies to prevent climate-related systemic risk (CRSR) while promoting low-carbon production is of great concern. Despite its significance for a stable transition to low-carbon energy, this topic remains underexplored in the literature. Our study examines the impact of monetary policies promoting low-carbon development on CRSR based on China's low-carbon transition scenario. To achieve this, we develop a financial network model with a forward-looking climate stress-testing framework. This model captures banks' heterogeneous behaviors regarding carbon asset allocation and the systemic feedback effects of climate policy shocks in a multilayer network. Our findings reveal that targeted reductions in the required reserve ratio (RRR) and carbon reduction re-lending policies have significant and distinct effects on CRSR. We also observe that larger banks tend to have higher systemic importance and are more responsive to adjustments in low-carbon monetary policies. By contrast, relatively smaller banks demonstrate greater vulnerability to climate policy shocks. Additionally, these policies influence CRSR through mechanisms involving credit restructuring and interbank network interconnectedness. This study provides valuable insights for enhancing low-carbon financial policies and facilitating a stable low-carbon transition.