So Why Aren’t Commercial Banks Lending on Energy Efficiency?
With all the talk about the strong business case of energy efficiency retrofits, why aren’t we seeing private sector commercial banks committing significant capital to the energy efficiency retrofits of buildings?
UNEP-FI thinks that they know the reasons why. Energy efficiency (EE) has been widely documented as the ultimate low-hanging fruit — yet commercial banks are leaving it dying on the vine. The famous McKinsey report, for example, indicates that energy efficiency should generate returns close to 17 percent. In the US, McKinsey calculated that EE could deliver close to 60% of all cost-effective emissions reductions in a scenario aiming for a 60-80% cut in emissions by 2050. The size of the untapped US energy service market is estimated at $160 billion. UNEP-FI has just published a report of its findings on this and related questions, based upon a survey conducted last year with its financial institution (FI) members. So you’ll get a more global view of bank perspectives on the topic, as opposed to just domestic US. Download report –>energy_efficiency-unep-fi (11) The responding FI’s attributed their lack of action on EE to problems with capital efficiency — how much it costs internally to lend on the often many small projects which typify energy efficiency measures. That’s typically a very expensive business process for large institutions, making them shy away from such business strategies. Then there are the knotty, interrelated problems of adequately identifying, mitigating and pricing the credit risks associated with the energy efficiency savings, which are more serious problems, in my view — and definitely worthy of a fuller discussion on a different blog post in the future. Here are explanatory excerpts from the report:
- Scale – individual projects are considered to be too small to be commercially ‘interesting’ for mainstream private-sector FIs…
- The “asset” problem – energy savings, which underpin the usual ESCO business proposition, are not a conventional ‘asset’ against which a bank will lend. In other words, cash-flow from energy savings is not a familiar form of revenue or collateral to back lending (although clearly any additional equipment provided would be an asset). This means that FIs, particularly local FIs, need to become familiar with the nature, as well as the performance and credit risks of energy savings financed projects in order to be comfortable with providing debt. Despite not being uniformly available, partial-risk loan guarantees aimed at reducing these risks and facilitating finance, particularly in developing countries, represent an effective approach.
- Lack of loan/credit guarantee mechanisms – linked to the above, loan/credit guarantee mechanisms can play a key role in facilitating finance, particularly for smaller scale ESCOs. Experience from some actors, however, indicates that the guarantee schemes that exist today are for larger amounts and involve a “tedious and long process for approval”. Developing lean credit guarantee mechanisms tailored to smaller-scale projects would help address this deterrent to energy efficiency lending activities.
At the end of the day, this report calls for more product development and sponsor education: banks should work to resolve the technical EE credit quandries along with raising EE to a board level action item. Board member education about the untapped market for energy efficiency for FI’s was strongly urged. That said, my view is that the issues regarding reliably assessing credit risk of EE savings and the development of adequate credit guarantee mechanisms for EE retrofit projects are two significant, hard-boiled issues that can’t be whisked away.
