Greening the financial regulation:Case of credit limit optimization for renewable energy

Abstract

The sense of urgency surrounding climate change is increasing over time, pushing the banking system to effectively align sustainable financial rules and project financing with the Paris Agreement’s Goals. Central banking lies on a set of instruments that address financial market functioning and financial stability at both the micro- and macroprudential levels. These instruments range from awareness to regulation and supervision. Our contribution consists in implementing one of these instruments, namely, credit limits, by employing mathematical modeling to optimize fund allocation in favor of the renewable energy sector, which is regarded as one of the least polluting. Our numerical application for a simulated bank portfolio has assisted in channeling a higher proportion of loans into renewable energy at the expense of other sectors that pose a high financial and environmental risk. Our findings have policy implications for both investors and policymakers.