The Green Trilemma of Banks and its Potential Solution: The Green Preferential Capital Requirements

Abstract The traditional trade-off between banks’ safety and income should be amended with a green factor creating the green trilemma. Banks must find the balance between the three mentioned goals. Firstly, we build up a formal model of the green trilemma and point out the need for incentives to support green lending. The introduction of green differentiated capital requirements can be a solution. However, there is little empirical experience about the application of this policy tool. Secondly, we assess the Green Preferential Capital Requirement Program (GPCRP) of the Central Bank of Hungary, which is a pioneer green supporting factor program. We measure the cost efficiency of this program. The cost is prudential, meaning that the benefit of prudential release is distributed between bank owners and green borrowers. The program’s unit cost is much below the current EU ETS prices. Our results underline the effectiveness of the program: without material increase in prudential risk, the GPCRP contributes to avoiding significant amounts of carbon emission.