The newest kid on the lending block comes in a green wrapper. It can be a little bit cheaper than a standard loan and a bit easier to access but what differentiates it from other products on the market is the purpose to which it is put. Green loans can be used to buy energy-efficient homes, finance energy-efficiency projects in business, buy electric vehicles, fund the development of wind farms, install solar panels, and a whole range of other environmentally-sound purposes.
“It is not the colour of the dollars,” says Theodor Cojoianu, assistant professor at Queen’s University Belfast and a member of the European Commission’s Platform on Sustainable Finance. “It’s how they’re used. The interesting bit about lending is that you can ringfence it and tie it to a particular asset or particular usage.”
In general terms green lending involves the lending of money to a borrower for the purpose of financing or refinancing a particular green project, says David O'Mahony, partner, finance and capital markets with Matheson. "For example, a green project could be as simple as a person or business borrowing money against a project to improve the overall energy efficiency of a home or a business premises."
There is another form of green lending, according to Paul Travers, AIB’s head of energy, climate change and infrastructure. “The second form of green and transition lending is where, while the proceeds of the loan are used for general business purposes, the rate the customer pays is adjusted as a result of the customer achieving their agreed sustainability targets.
“These are known as sustainability linked loans (SLLs). These loans help to target a reduction in businesses’ carbon footprint to ensure they are proactively keeping pace with the transition, changing customer preferences and the rise of green procurement processes.”
Travers says AIB is actively engaged in greening its loan book.
“This is about encouraging and supporting our customers to transition their activities towards net zero so that we all play our part in fighting climate change. AIB has both a responsibility and an opportunity to play a leadership role in the transition to a lower carbon future, and working with our customers to green their businesses and homes will in turn green our loan book.
“It makes not only good business sense for AIB but is also the right thing to do. Our lending is, therefore, taking an increased focus on supporting environmentally-sustainable economic activity, particularly activity that supports the reduction in carbon emissions which is key to combatting climate change. The bank is evolving its product suite to align to Ireland’s changing requirements.”
Liquidity
Green lending has an important role to play in tackling climate change, according to Mike Hayes, global head of renewables with KPMG Ireland.
“Everybody is talking about investing in decarbonisation and net zero. That all requires funding and green finance is mobilising the liquidity to pay for it. The banks are right to see the business opportunity there. They are tapping into the increase in climate consciousness. Financial institutions are also coming under more pressure to be green.”
Of course, some activities are greener than others and there may be questions around just how green a lending product is. “You can call just about anything green, it’s a very broad term,” says Hayes. “Green lending is defined by the purpose it is used for and the EU Commission taxonomy for sustainable activities sets out definitions for what is green.”
Cojoianu points out that the market has tended to come up with its own ways of defining green which may not be entirely scientifically aligned. "That's why the European Commission took it upon itself to come up with the taxonomy, a common classification system for sustainable economic activities."
However, the commission is shortly to publish more detailed classifications for some categories within the taxonomy, and there are fears that there might be some watering down with gas-fired power generation possibly defined as a sustainable activity in certain circumstances. He points to the energy performance standard (EPS) of 100 g CO2/kWh for new power generation in 2035 required to align with Paris Agreement targets. “That’s a measure of the carbon intensity of energy. Wind meets that standard in almost all cases, but gas doesn’t.”
Finance function
Regardless of those doubts, green lending offers considerable benefits to both lenders and borrowers. “There are the obvious environmental and reputational benefits,” says O’Mahony. “From a borrower’s perspective there is potential to get an improved interest rate and for companies with ESG policies in place it is a way of embedding those policies in the finance function.”
From a lender’s perspective, he says the cost in the capital markets of raising green financing is generally lower.
“There is huge investor appetite in the capital markets for green bonds, which means there is a strong demand which lenders can tap into. Increasingly there is a view that companies who have an ESG strategy are seen as better borrowers from a credit risk perspective.”
Last year AIB became the first Irish bank to complete a green bond issuance, raising €1 billion to help fund projects with clear environmental and climate benefits. “The bond represented a major vote of confidence by investors who recognised that AIB is increasingly playing a leading role in the transition to a green economy – including by funding the development and construction of energy-efficient homes and buildings and renewable energy projects,” says Travers.
The bond market also has the potential to drive the green agenda, according to Fabiola Schneider, a doctoral researcher at UCD Michael Smurfit Business Graduate School and Sherpa to the European Commission's Platform on Sustainable Finance. "Debt has a due date, and it has to be repaid," she explains. "Bond investors have a lot of power. It's quite common for debt to have conditions. They can say that they won't refinance debt unless the companies follow the green agenda."
Hayes believes we are at the beginning of something quite big when it comes to green lending. “The old maxim that it’s all about profit no longer holds. It’s about profit and purpose now. Societal good is becoming a very hot issue. Institutions investing in green bonds which are then used to fund green loans is part of the perfect virtuous circle that we are trying to create. We are a bit away from that yet, but it’s clear where the direction of travel is going.”