What are low-carbon finance mechanisms and instruments?
Low-carbon finance mechanisms and instruments incentivize investment in low-carbon and zero-carbon technologies and projects. These mechanisms and instruments can also facilitate private investment in clean technologies that struggle to attract investment in traditional financial markets. While this section focuses on three types of these financing tools, green banks, loan guarantees, and revolving loan funds, governments can also provide direct financial support through grants, rebates, or vouchers. While these other options do not have a repayment obligation, and therefore are more dependent on the availability of discretionary funding, they can be a simpler and more direct way to fund clean energy priorities.
Green banks are not depository institutions like well-known commercial banks, but rather public or quasi-public institutions that utilize limited public, private, and philanthropic funds to drive private capital towards emerging clean energy technologies. They are usually designed to support clean energy and climate solutions and achieve additional goals such as creating local jobs and building community resilience.
Loan guarantees are financial instruments that reduce the risk of investing in technologies that are unable to attract traditional private investment or compete in the commercial marketplace. They are contractual obligations where the government agrees to pay a portion of a borrower’s debt obligation if they default.
Revolving loan funds (RLFs) are mission-driven, self-replenishable pools of money that are used to make loans for clean energy projects. Government-sponsored RLFs often offer lower-cost financing than private lenders and can attract private sector finance through co-lending.
How do green banks, loan guarantees, and revolving loan funds work?
While they operate in several different ways, low-carbon finance mechanisms and instruments are used to reduce risks for private investors and costs for borrowers. In doing so, they utilize limited public funds to leverage additional private investment that wouldn’t have happened otherwise.
Green banks utilize several financial instruments and provide services to lower the cost of climate-related projects including by providing credit enhancements,[1] reducing administrative costs, and co-investing. For example, if private lenders are only willing to cover a portion of a project’s costs, green banks can step in to pay the rest. Many clean energy technologies face significant structural obstacles to wide-spread commercial adoption including , legacy energy infrastructure, and perceived financial risks of investing in emerging technologies. Green banks can provide a bridge between investors and borrowers to make it easier to finance projects that wouldn’t have occurred otherwise. These projects have many benefits including reducing carbon emissions, creating local jobs, and building community resilience.
Loan guarantees are designed to achieve specific objectives such as supporting the deployment of new, innovative technologies to reduce greenhouse gas emissions. Under a loan guarantee, borrowers receive a loan from a private lender with a guarantee that the government will assume a portion of the debt obligation if the borrower defaults. This reduces the risk for the lender, making it more likely that they will invest in a project, and can reduce the costs for the borrower if the lender provides a more generous interest rate in response to the government taking on a portion of the risk.
Revolving loan funds are also designed to achieve specific objectives and can be operated by state and local governments, utilities, higher education institutions, or nonprofits. They can be initially capitalized through several mechanisms including electric utility ratepayer funds and carbon pricing revenues. The initial capital is used to fund loans that contribute to the overall objective of the program. Once these loans are repaid with interest, the new capital is recycled to fund loans for a new project—making the fund self-replenishable. The program can be administered entirely by one institution or by multiple ones, such as a state energy office and private lenders. Also, the fund can solely invest public capital or co-invest with a private lender. In the latter arrangement, the collaboration can generate more finance than the government could have on its own and thereby improve rates for borrowers.
Key Design Considerations for Green Banks
How will the green bank be legally structured (e.g. nonprofit, government-run, or quasi-public)? How will it balance design considerations including administrative burdens, financing flexibility, liability, and access to funding?
How will the bank receive its initial funding and any ongoing appropriations (e.g. carbon pricing revenues, private funding, philanthropy, or general government revenues)?
What financial products and services will the green bank offer (e.g. credit enhancements through loan guarantees, technical assistance, or co-investment with private investors)? Will the bank be limited to providing pre-determined financial products and services or be given more flexibility to determine which services are best on case-by-case basis?
What is the mission of the green bank (e.g., to reduce greenhouse gas emissions, improve local air pollution, or create local jobs)? Are the bank’s investments attracting or replacing private sector investment?
Who will have oversight over the green bank? If the bank has a board of directors, how will the directors be selected?
Key Design Considerations for Loan Guarantees
What is the mission of the loan guarantee program? Which projects or technologies will the program prioritize?
How much of a loan will the government guarantee? How will the guarantee impact how much research the private lender undertakes to determine the borrower’s risk level? How will losses be shared between the government and the private lender in cases of default?
How can administrative burdens and operating costs be reduced? How will the program maintain financial durability? Will the program utilize a borrower fee or receive a regular congressional appropriation to cover losses when borrowers default?
Key Design Considerations for Revolving Loan Funds
How will the fund be initially funded (e.g. carbon pricing revenues, private capital, or bond issuances)?
What is the mission of the fund (e.g. to reduce greenhouse gas emissions, create jobs, or promote a specific technology)? How will projects be selected?
Who will operate the fund (e.g. state and local governments, utilities, or a nonprofit)? Will the fund only publicly finance projects or co-invest with the private sector?
U.S. experience
Green Banks: As of 2019, there were 16 green banks sub-nationally in the United States. Through December 2019, these banks have directly invested $1.5 billion and attracted an additional $3.8 billion of private investment, bringing the cumulative total to over $5 billion of investment since 2011. As an example, the Connecticut Green Bank was established in 2011 to reduce the costs of clean energy for consumers. In fiscal year 2019, the bank reported using $40.7 million of public investment to attract $312.7 million of private investment to create jobs, reduce pollution, and deploy clean energy.
Loan guarantees: Governments have used loan guarantees for several purposes including to support rural and small businesses, students paying for higher education, and innovative energy projects. For example, the U.S. Department of Energy’s Loan Programs Office coordinates the Tribal Energy Loan Guarantee Program to support tribal economic development, and the Title XVII Innovative Energy Loan Guarantee Program to promote innovative, advanced energy technologies. The latter program has provided over $25 billion in loan guarantees since 2007 and supports projects that utilize a new or significantly improved technology and avoid, reduce, or sequester greenhouse gases, among other factors.
Revolving loan funds: A majority of U.S. states operate energy-related RLFs. For example, the Texas LoanSTAR Program was initiated in 1988 as a state-wide energy efficiency demonstration program. The program finances energy efficiency retrofits on state-supported facilities with low-cost loans. The loans are repaid using the energy cost savings from the projects. As of May 2020, the program has saved Texas taxpayers more than $665 million.
Additional Resources
- Green banks:
- Congressional Research Service: https://fas.org/sgp/crs/misc/R40913.pdf
- American Green Bank Consortium: https://static1.squarespace.com/static/59bc05f0c534a543a9f96b0d/t/5edf9fbd8285f063f6c13bbe/1591713732941/2020+Annual+Industry+Report+Final.pdf
- Coalition for Green Capital: http://coalitionforgreencapital.com/wp-content/uploads/2019/07/GreenBanksintheUS-2018AnnualIndustryReport.pdf
- Coalition for Green Capital: http://cgcprod.wpengine.com/what-is-a-green-bank/green-bank-techniques/
- Duke Nicholas Institute: https://nicholasinstitute.duke.edu/sites/default/files/publications/a-guide-to-green-bank-design-in-the-southeast-web.pdf
- S. Environmental Protection Agency: https://www.epa.gov/sites/production/files/2018-10/documents/usepa_greenbankingstrategies_october_2018.pdf
Loan guarantees:
- Department of Energy: https://www.energy.gov/lpo/what-loan-guarantee
- Bipartisan Policy Center: https://bipartisanpolicy.org/blog/financing-novel-energy-technologies-how-the-loan-programs-office-advances-american-competitiveness/
- Department of the Treasury: https://www.treasury.gov/resource-center/sb-programs/Documents/LGP%20Best%20Practices_Sept%202015_v%20FINAL.pdf\
- Department of Energy: https://www.energy.gov/lpo/title-xvii
Revolving loan funds:
- Department of Energy: https://www.energy.gov/eere/slsc/revolving-loan-funds
- American Council for an Energy Efficient Economy: https://www.aceee.org/toolkit/2020/02/revolving-loan-funds
- National Renewable Energy Laboratory: https://www.nrel.gov/climate-neutral/revolving-loan-funds.html
- National Association of State Energy Officials: https://www.naseo.org/issues/energy-financing/revolving-loan-funds
[1] “Credit enhancement is a strategy for improving the credit risk profile of a business, usually to obtain better terms for repaying debt…A business that engages in credit enhancement is providing reassurance to a lender that it will honor its obligation. This can be achieved in various ways: by providing additional collateral; by obtaining insurance guaranteeing payment; or by arranging for a third-party guarantee.” Source: Department of Energy
