Published by International Energy Agency‌ > Newsroom & events > IEA journal > Issue 7 | 4 November 2014  |

IEA_logoBanks lead in lending, but they often need a helping hand

Banks are altering loans for building retrofits, like this one in Istanbul, to include costs to better energy efficiency.

Interest in financing energy efficiency is increasing worldwide, as are investment opportunities, with a dramatic expansion in recent years in the number and variety of funding programmes as well as the diversity of investors, financiers and intermediaries.

Many OECD countries in particular are trying to encourage the private sector to scale up investment in energy efficiency. Governments are accelerating this process with access to finance but also regulation, incentives, de-risking measures and capacity building.

Banks lead in lending but at times need help

Commercial banks are the largest lenders, with the Citi group, for example, having directed a total of USD 1.4 billion to energy efficiency activities from 2007 to 2013.

Banks take two approaches to such lending: demand-driven and strategy-driven. The demand-driven approach involves re-packaged
products, such as lending for commercial retrofits, mortgages extended to include energy-reduction improvements, or car loans for less fuel-thirsty cars. The strategy-driven approach assesses whether energy efficiency product types and target markets fit within a bank’s existing strategy or portfolio mix. For instance, a strategy-driven investment might improve an existing industrial client’s risk profile and profitability through better energy performance by replacing inefficient motors.

Commercial banks are also an important relay in channelling public finance towards energy efficiency. Many development banks and green investment banks, which specialise in lending for sustainable growth, distribute funds through local commercial banks, which in turn often provide complementary financing. The Asian Development Bank, for example, implemented energy efficiency loan projects in three Chinese provinces, providing USD 100 million to each respective government, with the funds re-lent through a financial intermediary. Public finance programmes are particularly important for consumer market segments that are underserved by private markets, such as small businesses or affordable housing.

Often the public sector must catalyse commercial lending when private financing faces challenges beyond such general barriers to improved energy efficiency as lengthy payback periods or situations where incentives and costs are misaligned between owner and lender.

To start with, projects are often diffuse and too small to attract lenders, raising development and implementation costs. In addition, the price – in expense, time or expertise – to arrange financing can be too daunting for businesses, especially smaller ones, as many lack the skills or bandwidth to meet project requirements or the cash to contract out the work. As the performance results for energy efficiency investment are generally not collected in a systematic manner, the paucity of transparent data and financial research can also block deals. Finally, some financial institutions fail to see energy cost savings as potential cash-flow sources for debt repayments. This is particularly an issue in industry, where investment in process change rather than new assets can achieve great savings.

Moreover, the public sector has a role as an implementer of projects, as when local agencies invest in efficient lighting for municipal buildings or in a government-owned enterprise’s use of more efficient industrial processes.

More generally, scaled-up lending is constrained by the lack of suitable vehicles with attributes sought by institutional investors: the options available often lack investment-grade credit ratings or related financial research.

Besides the detrimental effects on all forms of energy efficiency that result from subsidies for fossil fuels, the investment milieu often features government policies and regulations that favour investment in fossil-fuel use and production, as well as absent or low carbon prices.

Signs of growth in deals and savings

Despite these challenges, the IEA publication Energy Efficiency Market Report 2014 detects signs of acceleration in the rate of change in energy efficiency finance, indicating that growth should continue over the next several years. Supportive factors include a wider variety of tailored financial products, a gradual increase in the amount of energy and loan performance data, and increased attention to related policy issues such as climate change mitigation and energy security. Plus, as markets mature, the menu of financial products should expand and the access to data increase, further boosting activity.

Additional growth can come from improved co-ordination among the investor, policy and financial communities as well as better appreciation of the multiple economic and social benefits of energy efficiency, from greater employment to reduced public expenditure.

This article by Lorcan Lyons, a recently arrived analyst in the IEA Energy Efficiency Unit, appears in the new issue of IEA Energy: The Journal of the International Energy Agency. Lorcan Lyons was previously a consultant on energy and environment policy with Bio Intelligence Service and before that worked at the IEA from 2004 to 2008.

The IEA produces IEA Energy, but analysis and views contained in the journal are those of individual IEA analysts and not necessarily those of the IEA Secretariat or IEA member countries, and are not to be construed as advice on any specific issue or situation. Click here to read the new and earlier issues of IEA Energy.

Photo by saragoldsmith on Flickr,