The effect of carbon taxation on bank risk in Sweden

Abstract

This study uses panel data and fixed effect modeling to analyze the impact of Swedish carbon taxation on liquidity risk and overall risk for banks operating in Sweden. Liquidity risk is measured by the Liquidity Coverage Ratio (LCR) and overall risk by the natural logarithm of the inverse Z-score. Additionally, we analyze the individual components of the Z-score for deeper insights. Our main findings reveal the following: The Swedish carbon tax has a significant positive effect on liquidity risk but does not show any significant result for overall risk. The positive effect indicates lower liquidity risk for banks, suggesting that they are in a beneficial position to handle future increases of the carbon tax in terms of the LCR. Furthermore, our analysis incorporates an interaction term between bank size and the Swedish carbon tax. The results show that the positive impact of carbon tax on liquidity risk decreases as bank size increases, and the positive impact of bank size on liquidity risk decreases for banks facing higher levels of carbon taxation.