What is a carbon bank?
A carbon bank would provide financial services to entities that develop or invest in carbon removal projects. It could either be established as a new public or quasi-public financial institution dedicated to financing carbon removal, or as a carbon removal-focused arm of a national green bank that also finances clean energy and other greenhouse gas reduction projects. The carbon bank may provide a different or broader range of financial services than existing green banks, however, to meet the needs and unique circumstances of carbon removal projects, and nature-based projects in particular.
A carbon bank would fill two complementary needs for carbon removal projects: reducing the risk associated with project development, and attracting private investment to defray the upfront costs of new technologies or land management practices. By directing both public and private capital into carbon removal projects, a carbon bank would help scale up new practices and technologies and accelerate the removal of carbon from the atmosphere more effectively than either public expenditures or private markets could on their own.
How does a carbon bank work?
A national carbon bank could be established under the purview of an existing agency, drawing capital from new or existing funding sources within the agency; as an independent nonprofit institution capitalized by the federal government; or within an existing nonprofit institution such as a national green bank. The carbon bank would have the authority to provide financial services to eligible entities including landowners, non-profits or private companies that either develop or invest in projects expected to contribute to carbon removal benefits.
The head of the relevant agency or an independent board may assume responsibility for determining eligible project types, which may include nature-based practices (such as reforestation) and/or technologies (such as direct air capture) that directly remove carbon from the atmosphere, as well as activities that are necessary to scale up these practices and technologies (such as tree nurseries or CO2 pipelines). The carbon bank may also draw on established methodologies for estimating carbon removal benefits from eligible projects if necessary for outcome-based financial services (e.g., payments per ton of carbon removed or interest rates tied to benchmarks for carbon removal).
A carbon bank may provide a broad range of financial services that enable investment in and development of eligible projects. Sample services that a bank could provide include:
- Low-interest loans: a borrowing instrument with an interest rate lower than what the borrower could receive from other financial markets, where the borrower repays the principal and interest after a set term. Low-interest loans reduce the cost of capital for project developers, helping them to manage the high upfront costs associated with most carbon removal projects.
- Loan guarantees: an arrangement where the government assumes a portion of the debt obligation if the borrower defaults on a private loan. Loan guarantees reduce the risk for lenders to invest in carbon removal projects, helping to attract private investment in carbon removal projects that would otherwise be considered too risky for private lenders .
- Bond guarantees and credit enhancements: arrangements where the government either assumes a portion of the debt obligation if a bond issuer defaults on bond repayments or provides additional collateral to the bond issuer to reduce the risk of default. Both bond guarantees and credit enhancements reduce risk for private investors that buy bonds, allowing capital-intensive carbon removal projects to attract additional investment.
- Direct payments for carbon removal outcomes: a system where the government pays project developers directly for each ton of carbon their projects remove from the atmosphere. Direct payments may be most appropriate for carbon removal projects without other expected revenue streams, such as carbon credit sales, timber harvests, or enhanced oil recovery, to repay government loans. A carbon bank could contain the public costs of direct payments by using a competitive bidding process such as a reverse auction, which allows project developers to offer a payment level at which they would be willing to undertake carbon removal. Direct payments for nature-based projects could complement or subsume existing direct payment programs administered by the U.S. Department of Agriculture (USDA).
Like any bank, a key function of a carbon bank would be assessing project risk as part of the bank’s due diligence in project selection and determination of contract provisions. While some risks in carbon removal projects are analogous to risks in any other sector, some project types may also carry unique risks—like the risk of reversal for nature-based projects, whether intentional (e.g., clearing reforested land or terminating soil carbon management practices) or unintentional (e.g., forest fires or flooding on agricultural land). The carbon bank must have access to the appropriate technical and financial expertise to understand and mitigate these sector-specific risks, such as through partnerships with other agencies or carbon market institutions.
Key Design Considerations for Carbon Banks
How will the carbon bank be structured? Will it be established under the purview of an existing federal agency (e.g., USDA or Department of Energy), within a national green bank, or as an independent nonprofit entity? What level of oversight will the federal government have over the carbon bank’s operations? How will management and advisory board membership be selected for the bank?
How will the carbon bank receive its initial funding (e.g. through the Commodity Credit Corporation or other government revenues)? Will the bank receive annual mandatory or discretionary appropriations?
What project types will be eligible for financing by the carbon bank? Will the bank focus on scaling up commercially viable solutions, or will it also invest in early-stage demonstration projects? Will it focus only on nature-based projects or finance technological carbon removal projects as well? Will projects that participate in voluntary or compliance carbon offset markets be eligible for financing? Will the bank allow financing to flow through project aggregators or other financing institutions, like state-run green banks?
What criteria will the carbon bank consider in choosing which projects to finance? How will the bank balance due diligence needs with transaction costs for applicants in designing applications for financing? How will the bank evaluate project risks, such as the reversal of carbon removal back into the atmosphere?
What financial services will the carbon bank offer? Will these services be predetermined by Congress, left to the discretion of the bank’s management, or selected by an independent advisory board? Will any of the financial services offered be linked to carbon removal outcomes?
What contractual protections will the bank require to limit its potential liability for intentional reversals in nature-based projects? If any of the financial services offered are outcome-based, how will actual carbon removal volumes be monitored and verified?
While no analog to a national carbon bank currently exists, the federal government has provided many of the same financial services in the past to meet social and environmental objectives. For example, the U.S. Department of Energy guaranteed loans worth over $16 billion to clean energy projects between 2009 and 2011 as part of the American Recovery and Reinvestment Act (ARRA). Clean Water State Revolving Funds, which match federal funding with state resources to finance water quality infrastructure, have issued over $4 billion per year in low-cost financing, with a national average interest rate of 1.5% in 2019. The Community Development Financial Institutions (CDFI) Fund has issued nearly $1.6 billion in bond guarantees for building and infrastructure projects since its establishment in 2010. The U.S. Department of Agriculture spends about $6 billion per year on direct payments to farmers and other landowners who implement natural resource conservation practices on their land. The value of a national carbon bank would be to target this full array of financial services specifically toward carbon removal and consolidate them within a central lending authority.
The National Climate Bank Act (S.2057), introduced in 2019, would establish a National Climate Bank as a nonprofit entity with $10 billion in initial federal funds and a subsequent annual appropriation of $5 billion. The proposed National Climate Bank would in many ways act like a green bank, as it would provide financing to a wide range of clean energy technologies as well as to existing state and local green banks. While it does not have a specific focus on carbon removal as a carbon bank would, some provisions of the National Climate Bank Act align with carbon bank services. These include the ability to finance nature-based projects, like reforestation and agricultural best practices, and the inclusion of a reverse auction mechanism for direct payments in the form of a “cash for carbon” program (albeit for decarbonization of the power sector, rather than for carbon removal). Other proposed legislation would also provide services similar to a carbon bank; for example, the Rural Forest Markets Act of 2020 (S.4451) would guarantee loans for forest projects that participate in environmental markets.