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1 May 2016 CFA Institute Journal Review

Green Banks: Growing Clean Energy Markets by Leveraging Private Investment with Public Financing (Digest Summary)

  1. Marc L. Ross, CFA

The rise of clean energy can progress only with more rapid and cost-effective deployment. The author discusses green banks, which offer an innovative financing solution.

What’s Inside?

Global warming is increasingly motivating people to find clean energy solutions. Although clean energy solutions are rapidly growing and gaining acceptance, continued proliferation of commercially viable technologies will require more efficient access to capital. To fill this void, “green banks” represent a collaboration between private investment and public financing.

How Is This Research Useful to Practitioners?

New low-risk technologies are being deployed around the world to tackle global warming but not quickly enough. Investment in renewable resources must maintain a fivefold increase for at least 25 years. The world’s outsized reliance on the mature fossil fuels industry to supply power, fuel transportation, and run industry has increased energy-related CO2 emissions by more than 50% in the past 25 years.
The US federal government and state governments have used subsidies to increase investment in renewable technologies to bring down costs through improved scalability and deal economics. But subsidies are an expensive use of taxpayer dollars, and failing to bring renewable technology markets to scale results in a failure to cover project costs. Rapid, efficient, and cost-effective implementation of clean energy alternatives is necessary to address global warming.
Green banks are a promising financing alternative and represent a form of public/private partnership to drive or “crowd in” additional private investment. An array of financing tools and structured alliances can help attract private investment at a lower cost to preserve public money because the project represents investment in proven and economically viable endeavors. The private and public sectors, as well as consumers, could benefit from the myriad of product choices and financing options that are currently available in some states.
Regulators and students of public policy will find the green banking solution a welcome means to address the funding challenges that clean energy technologies face. Securities analysts and portfolio managers may acquire fodder for idea generation.

How Did the Author Conduct This Research?

The author reviews data and findings from the International Energy Agency. Unlike the fossil fuels industry, which tends to have access to cheap capital, clean energy projects often lack access to much-needed financing— partly because of lack of familiarity with the technology and a dearth of institutions focused on clean technology.
Although it has made substantial progress in the past 10 years, clean energy technology is still new, and so are the means to finance it. The introduction of green banks, which function as a public/private partnership that facilitates the involvement of private money while conserving public dollars, can serve a developing sector in search of scalability.
Created through legislation and funded with public money, a green bank can be a public or quasi-public institution that is either directly part of or an instrument of government. Unlike a governmental entity that receives annual appropriations, a green bank places funds on the balance sheet for lending and does not accept deposits like a traditional bank. Green banks’ loan rates need to cover only operating expenses and investment risk because they receive public money with no need to pay interest to the state. These banks form public and private alliances to fund specific projects rather than commingling funds at the institutional level.
Green banks use a variety of financing techniques, such as credit enhancements (to attract private investors through loan guarantees), co-investment (types of bank loans made alongside forms of private investment), and warehousing/securitization (underwriting, pooling, and holding loans until scale is attained, at which point the bank sells them through private placement or securitization). Green banks also use different types of delivery structures to increase a lender’s security, including property assessed clean energy (PACE) financing and on-bill financing/repayment. PACE financing enables repayment of an energy upgrade loan through property taxes from a new lien on a building in the same amount as the loan repayment; the tax agency remits payments to the lender. On-bill financing/repayment allows for repayment of an energy upgrade loan through a customer’s utility bill, splitting incentives between a building owner and its tenants.
The Connecticut Green Bank, as an example from the United States, has the most experience using the aforementioned financing alternatives and delivery mechanisms. It has grown clean energy markets substantially, reducing costly grants in the process. The bank also successfully built a scalable PACE loan portfolio and commercially securitized it, marking a first step in developing a secondary market for clean energy.

Abstractor’s Viewpoint

Green technology is a promising and necessary endeavor that needs to experience exponential growth to meaningfully combat global warming. Existing financing methods have been costly, inefficient, and insufficient. Green banks, which are gaining acceptance as a financing expedient in the United States and abroad, meld public and private money through innovative funding options and delivery methods to increase flows to the renewable energy sector at a low cost. Further investigation into structured financing methods as they develop around the world could be the object of future research. Investors who ignore the renewable energy sector do so at their own peril.

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