Prof. Manal Mahmoud Khairy: Green Banks

Green Banks are mission-driven institutions that use innovative financing to accelerate the transition to clean energy and fight climate change.

Being mission-driven means that Green Banks care about deploying clean energy rather than maximizing profit. They actively develop a pipeline of clean projects and seek out opportunities in the market.

All Green Banks have the mission to address climate change, though many also have additional objectives such as improving resiliency or serving low-income communities.

Going green often doesn’t come cheap for consumers.

Be it electric cars, sustainable clothing or another green alternative, eco-friendly products tend to come with an added cost.

However, banks can offer their customers green banking products which don’t cost the earth.

Green Banking Products

In fact, banks can go further than that and provide green banking products which incentivise consumers to make green choices.

To illustrate how, let’s take a look at a few examples of green retail banking products:

⦁ Green car loans – Customers are offered lowered interest rates for purchases of electric or low-emission vehicles.

⦁ Green savings and bonds – These allow individuals to invest in projects with a focus on environmental or social issues.

⦁ Green mortgages – Available to people purchasing homes with an energy efficiency rating of A or B.

⦁ Green home modernization loans – These enable homeowners to make energy-saving renovations to their properties.

Green Bank Techniques

Credit enhancement:

Green Banks can attract more private capital at affordable rates through credit enhancements.

Financing structures, such as loan loss reserves or loan guarantees, help de-risk investments for private investors, enabling more capital to flow to clean energy projects.

If a private investor is hesitant to enter a new market or is only willing to offer unfeasibly high interest rates, a credit enhancement can provide security to a lender and improve deal economics for the borrower.

 And because these tools are only used to support mature, low-risk technologies, the credit enhancements allow investors to become familiar with viable markets while minimizing public sector expenditure.

Aggregation and warehousing:

Inefficiencies of scale represent a significant barrier to private investment in small and geographically dispersed projects, like residential or small business energy efficiency projects.

By their nature, the projects are relatively low-cost and may differ in terms of credit, technology and location. This makes the projects relatively expensive to underwrite for a bank.

However, if a pool of these kinds of loans were bundled together to diversify risk and achieve scale, the projects then become far more attractive to lenders.

A green bank can accomplish this by underwriting loans directly and warehousing them until the scale is reached.

The green bank can later sell the loans to private investors through securitization or private placement, replacing public dollars with private capital.

Technical assistance:

When a technology or transaction type is unfamiliar, it requires more work to complete the deal and costs end up higher.

The cost of capital in clean energy markets can be reduced by creating more standardized lending documents and processes.

Larger capital markets, like those for homes and cars, have broadly standardized their underwriting process and contract language, thus reducing cost and uncertainty in the lending process.

Green banks can take on some of this labor and work towards the establishment of scalable, standardized frameworks to reduce these costs.

Co-investment:

Green banks can directly invest in a clean energy project—through senior debt, subordinated debt, or other mechanisms—in partnership with private investors.

If a project is only able to secure financing for a portion of the costs, green banks can provide the gap financing needed to close a deal.

Green banks can form many kinds of investment structures to fill the needs of a given project or fund, with varying levels of public-to-private leverage.

On-bill financing:

On-bill financing (or on-bill repayment) is a structure through which an energy upgrade loan is repaid through the customer’s utility bill.

This structure creates greater security for the lender because utility bills have historically had a very high rate of repayment.

On-bill financing has additional benefits too, because it addresses the split incentive between building owners and tenants.

By attaching a loan to a utility meter, rather than the customer, a tenant can reap the benefits of efficiency, repay only the portion of the loan that is due while still a tenant, and then hand the remaining payments to the next tenant who continues to benefit from the efficiency.

This model has the power to open up many new markets for efficient financing.

Like PACE, a Green Bank could act as a program administrator and/or lender for on-bill programs.

Note: On-bill financing typically refers to programs where the utility itself uses its own capital to issue the loans.

On-bill repayment refers to the programs that allow non-utility lenders to issue loans, where the utility merely acts as a collection platform.

Information sharing and coordination:

A critical barrier to customer adoption of clean energy solutions is lack of clear information on the value, the process and the options for purchase.

Many governments now offer multiple programs to support clean energy deployment, which may include subsidies, rebates, loans technical assistance, REC procurement and others.

Yet this support and information is often scattered across multiple agencies and utilities, making it difficult for consumers to understand their options to use all tools that are available.

A green bank can help coordinate the use of these resources by serving as a single point of contact for consumers seeking multiple forms of support.

Advantages and Disadvantages of Green Banking

Advantages:

Lower Energy Costs: Green Bank financing helps deploy clean energy solutions that can lower energy bills for consumers and businesses with no upfront cost Driving Private Investment:

The Green Bank concept is based on the reality that the public sector alone cannot supply the amount of capital needed to rapidly transition to a clean energy economy.

Therefore, the Green Bank is designed to drive and ultimately rely on private sector investment

Economic Development and Job Creation:

Energy projects must be built locally, which means local businesses and jobs will be created to serve the increasing demand for clean energy

Less Documentation:

In bank guarantees, there is a lesser requirement for documentation.

Only the information about the concerned parties, the details about the transaction about which guarantee is sought, financials of the applicant are generally demanded by the banks.

The level and extent of documentation may change depending on the lender’s policy and credit period.

Creating awareness to businesspeople about environment.

Sanctioning loans at comparatively lesser rates.

Disadvantages

Diversification problems: green banks restrict their business transactions to those business entities who qualify screening process done by green banks. With limited number of customers, they will have a smaller base to support them.

Startup face: Many banks in green business are very new and are in startup face, it takes 3 to 4 years for a bank to start making money thus it does not help banks during recession.

Higher operating cost: green banks require talented, experienced staff to provide proper services to customers.

Experienced loan officers are needed with additional experience in dealing with green businesses and customers.
Reputational risk:

If banks are involved in those projects which are damaging the environment, they are prone to loss of their reputations.

There are also a few cases where the environmental management system has resulted in cost saving, and an increase in bond value.

Credit risk: Credit risks arise due to lending to those customers whose businesses are affected by the cost of pollution, changes in environmental regulations and new requirements regarding emissions levels.

It is higher due to the probability of customer default due to uncalculated expenses for capital investment in production facilities, loss of market share and third-party claims.

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