Green finance aims to reduce greenhouse gases (mainly carbon dioxide, methane, and water vapour) emissions (GHG) in our environment.
As defined by the United Nations Environment Programme (UNEP) defines “green financing is to increase the level of financial flows (from banking, micro-credit, insurance, and investment) from the public, private and not-for-profit sectors to sustainable development priorities.
A key part of this is to better manage environmental and social risks, take up opportunities that bring both a decent rate of return and environmental benefit, and deliver greater accountability.”
Banks and financial institutions are promoting and providing funding for green finance projects globally. In the light of the significance of green finance, the State Bank of Pakistan (SBP) announced the Green Banking Policy in 2017 to promote green finance in the country, but the desired results have not been achieved since then.
As a layperson, it is crucial to understand whether green finance is different from conventional finance. If so, what are the incentives to use green finance, and what kinds of projects does it sponsor?
Green finance does not mean financing renewable and energy-related projects but financing firms with the condition that they will invest in green technology. Conventional financing is a traditional facility where financial institutions sponsor all kinds of projects without giving any attention to the environment.
In the wake of technological progress, changes in market dynamics, and a substantial increase in environmental pollution, the concept of green finance evolved. Being the market leader, China initially introduced green finance wherein a firm can borrow funds and take appropriate measures to curb pollution thereby making the environment greener.
Likewise, financial instruments such as green IPOs, green bonds, green loans, etc., were launched to attract the attention of firms and investors. However, no similar provision is available to introduce these instruments in Pakistan, which indicates that the scope of green finance in Pakistan is limited. Therefore, concerned agencies must formulate a policy for each instrument so that borrowers and investors can participate in new modes of financing.
To promote the culture of green finance in the country, it is essential to showcase the incentives available for borrowers. Presently, there are no specific distinctions in the provision of green and conventional finance.
The same conditions associated with traditional finance apply to green finance. If the SBP intends to stimulate and promote green finance projects, it must introduce some new incentives besides the general provisions related to conventional finance.
A special package may be introduced for financial institutions and borrowers that provides a mix of incentives to accelerate the pace of green finance in the country.
The interest rate may be capped at a maximum level (KIBOR + 2%), encouraging potential borrowings. It reduces the probability of charging a different spread and keeping the rate fixed may motivate financing in green projects.
Under conventional finance, the entire loan amount is classified and a provision of 25% is made when late payments exceed 90 days. As green financing is made for an extended period, a loan is classified depending on the life of the funding. For example, the tenor of the loan is five years; 25% of the loan may be classified as 1.25 years from the date of default, 50% in 2.5 years, and the rest in 5 years. Moreover, the return on green finance projects is lower; therefore, banks may allow some flexibility in charges associated with late payments.
Tax incentives may be introduced for financial institutions to promote green finance. For instance, if a financial institution has 10% gross advances relating to green finance, they may get a tax rebate of 10% (e.g., if the tax rate is 35%, and considering this assumption, a tax rate of 25% to be charged from the financial institution).
The default risk of borrowers creates a problem on the part of financial institutions as classified loans adversely affect profitability. In borrowers’ default, a bank may face loss exposure. For green finance projects, risk-sharing may be considered (say risk-sharing of 50/50 where a bank may face a loss of 50% and SBP bear a loss of 50%). This proposal may build confidence on account of financial institutions to finance green projects and contribute toward a greener Pakistan.
In short, currently, there is no difference in lending provisions between green finance and conventional finance. However, the regulator and banks can play a crucial role in the market of this financing segment by identifying incentives that encourage and promote green finance. Moreover, fast processing in terms of green finance may motivate the investors to initiate their projects. Similarly, banks can also identify green finance projects and facilitate the borrowing process.
On the other hand, the SBP may amend prudential regulations and add new clauses that encourage green finance. It is important to mention that SBP has different prudential regulations for agriculture financing. Along similar lines, prudential regulations may be modified to finance green projects. These proposed actions may help lead to green technology, a green economy, and sustainable growth in the country.
(The writer is associated with the School of Social Sciences and Humanities, National University of Sciences & Technology (NUST), Islamabad. The views expressed in this article are not necessarily those of the newspaper)
Copyright Business Recorder, 2022
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