Banks need liability innovation to lower green loan costs

ASEAN needs over $1 trillion to decarbonise by 2030.

As ASEAN faces a $1 trillion investment gap to decarbonize its economy by 2030, banks are under pressure to make green finance more accessible. According to Sam Ridgeway, Principal at Oliver Wyman Singapore, while banks have made strides in green finance, significant innovation on the liability side is needed to reduce green loan costs and drive wider adoption.

"Banks have been doing a wonderful job the last few years with growing their green finance," said Ridgeway. He noted that banks have been setting targets for green lending, often exceeding them, which has motivated further expansion. 

"They've been doing this both in the typical areas you might think of, such as financing green technologies and green projects. So renewables and others, for instance, they've also been getting increasingly creative with the ways that they're setting up green loan programs and products,” he said.

However, while banks have succeeded in increasing green lending, the cost of these loans remains a challenge. "At the moment, the issue is that a small discount is often given on green loans, and that discount is coming directly out of the bank's profits," Ridgeway explained. 

The key challenge, according to Ridgeway, lies in the current funding structure for green loans. "The cost of funding for a green loan is not meaningfully different to the cost of funding for a conventional loan.”

"We think by having some innovation on the liability side, creating specific green liabilities or other structures could systematically lower the cost of funding for green loans," Ridgeway suggested. One possible solution is the creation of green covered bonds, which would use green loans as collateral. "You could pass on that structural discount to those green loans," Ridgeway said, further suggesting government guarantees for pools of green loans or blended finance as other potential approaches.

These innovations could help banks de-risk green loans, thereby lowering the pricing for customers and making green finance more attractive. "In doing so, hopefully, we can accelerate the offering of green loans by incentivizing more customers to take them based on the pricing as well as on other characteristics," Ridgeway said.