Green is the colour of money and nature

Nepal’s public and private banks start to work together to finance a green economy

19 May 2022

- Angel Li

In March, the World Bank approved a $150 million ‘Finance for Growth’ credit line to strengthen Nepal’s financial sector for green, resilient, and inclusive development. However, critics say lack of money has never been the issue for the country to make a transition to renewable energy, it is the dearth of political will.

The Finance for Growth loan package kicks off a new climate agenda for Nepal by promoting climate finance resilience policies in banking, insurance, and capital markets, which lay the groundwork for the adoption of green loan incentives and new insurance and capital market products that are tailored to meet climate challenges.

It also hopes to improve supervision of the banking sector to address financial stability risks in the context of the pandemic, foster financial product innovations through opening up capital, insurance, and disaster risk financing markets, and increase liquidity and inclusion through access to external commercial borrowing, financial literacy, and financial digitalisation.

“This credit creates a strong foundation for a more stable, less bank-centric and more inclusive financial sector that is better positioned to mobilise private investment and support real economic activity,” says Peter Mousley, the World Bank task team leader for the project.

Indeed, green banks have the potential to reduce financing risks, finance underserved markets, attract foreign investment, fulfill national renewable energy targets, and help to fulfill carbon reduction commitments. But to fully tap into the potential of green financing, both public and private sectors will have to make efforts.

Nepal Rastra Bank (NRB) has been the key driver behind spurring sustainable finance in the country. In a recent report by the IFC-facilitated Sustainable Banking Network (SBN) titled Necessary Ambition: How Low-Income Countries Are Adopting Sustainable Finance to Address Poverty, Climate Change, and Other Urgent Challenges, green finance has been identified as a top priority in Nepal’s financial sector.

NRB launched the first policy document in 2018 Guideline on Environmental and Social Risk Management (ESRM) for Banks and Financial Institutions . which marked Nepal’s sustainable finance policy implementation, which has since progressed from ‘formulating’ under the ‘preparation’ stage to ‘developing’ under the ‘implementation’ stage (See chart). 

Source: 2019 Country (Nepal) Progress Report of SBN, Addendum to SBN Global Progress Report.

In 2020, NRB issued a Unified Directive to require all banks and financial institutions to integrate environmental and social risk management into their overall credit risk management process as well as policymaking.

Furthermore, the Netherlands Development Finance Company (FMO), has been collaborating with NMB Bank to work in renewable energy, hydropower, and green project financing. It is providing loans and equity investment for the Environmental and Social Management System (ESMS), and by doing so it will likely invite more equity investments in small and medium enterprises (SME).

Moreover, by providing credit to SME clients instead of big corporations, FMO supports equity investments in private equity funds such as Dolma Impact Fund I and II. Companies such as Nepal Invests aim to attract more capital from Development Finance Institution (DFI) to the Nepal financial system. However, to be eligible for loans by DFIs, ESMS is often a prerequisite. Nepal Invests is helping other banks to meet that necessary condition.

SMEs have been a crucial player in Nepal’s growth, making up about 20% of GDP and accounting for over 60% of employment opportunities in the country. In 2020, IFC provided a $25 million loan to NMB to help finance green projects and SMEs. This investment will expand NMB’s SME portfolio to over $1 billion by 2025 and generate 50,000 more jobs. The quantity of loans available to SMEs from NMB is expected to double as a result of the project.

“The chances of receiving funding will be exponential if SMEs are in sync with international best practices such as environmental, social and governance measures, we have demonstrated that risk capital can help mitigate climate change,” says says Siddhant Raj Pandey, CEO of Business Oxygen (Bo2), Nepal’s first international Private Equity Impact and Climate Related Fund. “To have an inclusive model, climate-smart approaches and transparent operations are critical to the success of companies.”

The critical next step for Nepal’s green finance will be expanding the adoption of the Environmental and Social Risk Management (ESRM) Guideline to other banks across the country. Building the capacity of regulators and financial institutions, strengthening implementation coordination, and developing a taxonomy of green and socially inclusive initiatives are among the central bank’s top priorities. These would provide a favorable and enabling environment for sustainable finance and open up green finance projects.

But for the private sector to invest in renewables and include green finance in their agenda, the government needs to provide them with incentives. For example, the other renewable energy sectors should get the same favorable treatment such as tax breaks much like hydropower. Private players such as Multilateral Development Banks (MDBs), industry associations, and local financial institutions can tap into the field.

Green banking has got a strong start in the public sector, but private parties are lagging behind and they should get on board to secure a better and safer financial system. Since private equity and venture capital are still relatively new concepts in Nepal, the role of the Nepal Private Equity Association (NPEA) become crucial in providing the ecosystem for a lobbying platform.

Business Oxygen, a climate-focused fund with investments from the IFC, Climate Investment Funds, and the FCDO, has been investing in and promoting climate-smart approaches. The firm measures investment’s success not only through impact numbers on the financial statements but also metrics in accordance with the UN’s Sustainable Development Goals.

It has a separate fund dedicated to providing technical support to companies whose financials are not able to comply with environmental, social and governance measures. ESG compliance monitoring is essential to the investment decision-making process. “Impact is an intentionality of our investment not just a by-product,” says Pandey of Bo2.

However, as a foreign direct investment (FDI) company, there are many policy and regulation challenges. Early on, Bo2 had a good pipeline of companies in the agricultural sector, but they were discontinued due to the Foreign Investment and Technology Transfer Act (FITTA) which prohibited FDI investment in agriculture. Later, the government raised the investment threshold limit from Rs5 million to Rs50 million which forced SME investors to diversify their strategies.

One area where Nepal is continuously and successfully bringing in investment is the green hydro project with experience of over 20 years. Investor trust is built upon sufficient human resources and a proper supply chain of equipment including turbines and hydro, mechanical and electromechanical machinery required.

“Even very risky hydro projects can still receive 70% of debt financing from local banks here in Nepal,” says Kushal Gurung, CEO of Windpower Nepal, adding that hydro projects are easily financed under an established ecosystem and intact supply chain.

But this is not the case for other green projects such as wind and solar where debt financing remains a challenge. The lack of trust from banks stems from a much shorter track record and low confidence in the revenue model.

But the good news is that such green projects need much lower investment. This allows private investors to come in and provide equity financing. “A solar project can be entirely financed by private equity investment with zero debt financing unlike hydropower where the opposite is true,” adds Gurung.

The climate crisis has added to problems like water availability, spatial-temporal distribution, and alteration in the hydrological cycle have been altered. Last year, Nepal’s electricity generation declined by 6.9% and this is expected to get worse, especially in the dry season. Nepal’s 15th Five Year Plan (2019-2024) has set a key target to achieve a 12% share of renewable energy in overall energy consumption. In 2022, it is a mere 3.27%.

An energy resilient Nepal needs effective collaboration between public and private entities. Public financing is insufficient but by greening the system with government subsidies, will save both the ecology and economy.

Angel Li is a student at Pitzer College in California.