China’s central bank begins pumping liquidity into decarbonization projects via new facility

The People's Bank of China (PBOC) has started to provide low-cost loans to fund decarbonization activities via a scheme that financial experts say could play a key role in helping the country reach its climate goals.

Under the carbon emissions reduction facility (CERF) launched 8 November, Chinese financial institutions licensed to operate nationwide can apply for PBOC funds to support their loans to clean energy, energy conservation, and environmental protection projects.

Sun Guofeng, head of the Chinese central bank's monetary policy department, said 30 December that the first batch of funds totaling CNY 85.5 billion ($13.4 billion) were already distributed to lenders to back decarbonization projects that can cut CO2 emissions by 28.8 million metric tons.

"The PBOC will continue … to help China reach the goals of reaching peak CO2 emissions by 2030 and carbon neutrality by 2060," Sun said during a press conference, citing the country's national targets.

The central bank has not indicated an upper limit for the CERF funds. Based on the amount of domestic green loans, CCB Futures, a brokerage owned by state-controlled China Construction Bank, estimates that the PBOC could distribute CNY 1.26 trillion per year via the facility. Anhui-based Huaan Securities estimates the figure at CNY 1.8 trillion.

In a research note published last September, the International Energy Agency said China—the world's largest GHG emitter—needs an annual investment of CNY 4 trillion in its energy sector alone to reach the 2030 climate target.

While positioning the CERF as an important tool to promote China's decarbonization, the PBOC will have other policy measures to encourage green financing in the bond and equity markets, according to observers.

"Bank lending is important, but it is only one part of a company's capital structure," said Norman Waite, an analyst at the Institute for Energy Economics and Financial Analysis.

Thinktank E3G's Senior Policy Advisor Byford Tsang envisaged a potentially growing role for the central bank in China's green finance sector, with the CERF's scope likely to expand. "The impact could be modest at the start, as the scheme is confined to three types of eligible projects. But it could increase over time as the policy evolves," Tsang told Net-Zero Business Daily.

Conway Irwin, climate and cleantech research director at IHS Markit, described the scheme as "a step in the right direction."

"Many of the technologies with the potential to reduce industrial emissions, like carbon capture and sequestration, are highly capital intensive—any means of making capital at reasonable rates available to project developers could potentially help improve project economics," Irwin said.

Cheaper loans

According to the central bank, Chinese financiers need to lend to decarbonization projects at interest rates close to the prevalent loan prime rates (LPRs) before applying for the CERF funds.

As the LPRs are generally applied to borrowers with the highest credit ratings, Tsang expects many low-carbon project developers to benefit from the policy design.

"Banks, based on their own risk assessment and appetite, might offer the LPRs to project developers that would otherwise be exposed to a higher cost of capital," he said.

The current annual LPR stands at 3.8% for one year and at 4.65% for five years. Under the CERF, the central bank will provide Chinese lenders with 60% of the loan principal at an interest rate of 1.75% per annum for one to three years. This is at least 45 basis points lower than the inter-bank borrowing cost.

While the PBOC does not require Chinese banks to offer discounted loans, analysts said banks have strong incentives to lend more to emission reduction activities due to the rate spreads. This, in turn, is expected to push down the financing costs for green projects.

"If financial institutions are actively seeking out decarbonization projects to take advantage of the interest rate differential, that on its own has the potential to create competition among those institutions to find and fund decarbonization projects," Irwin said.

"If banks are competing to lend to projects, they're likely to offer advantageous rates to the most promising ones, and the rush to lend can also expand the pool of projects deemed investable and the number of companies that stand to benefit," she added.

However, Chinese financiers need to provide collateral for the funds they borrow from the CERF. The central bank said the financiers will shoulder any potential lending risks by themselves.

"The CERF program is clear that lending should be done at market rates … This seems designed to safeguard against a wasteful lending spree," Waite said. "It is also a statement on the economic viability of the companies the PBOC wants funded."

Project requirements

According to the central bank, the CERF is designed to support companies with decarbonization projects including solar power, wind farms, biomass, hydrogen, geothermal energy, energy storage with high efficiency, smart grid, carbon capture, storage, and utilization technologies, among others.

"At the initial stage, the support may be small in scope yet highly targeted, prioritizing industries that are in the early stage of development but have great potential for reducing carbon emissions if there is certain financial support," the PBOC said.

The central bank has not set a specific decarbonization target for each eligible project under the CERF. Financiers are only required to release emissions data on the projects they fund every quarter, though the figures need to be verified by third-party institutions.

"On the domestic political front, the more Beijing signals that decarbonization is a policy priority, the more pressure lenders and project developers will be under to display progress in this area, whether it's officially regulated or not," Irwin said.

With China expected to establish emission targets for various industries in the coming years, Tsang suggested the central bank could have more requirements for projects receiving CERF funds in the future.

"It is possible further down the line that the government would link the lending to sector goals or to introduce some minimum threshold in terms of the emissions-saving potential of projects," he said. "But before that, the authorities should focus on making sure the disclosures from the lenders and project developers are robust, and on reviewing the scope of eligible projects where appropriate."

"This will safeguard the integrity of the scheme and ensure it contributes to China's climate goals meaningfully," he added.

To maintain their access to the central bank facility, Chinese lenders need to ensure that the projects they fund can lead to legitimate emissions reduction consistently. This requirement suggests the PBOC is hoping to train Chinese bankers in evaluating the decarbonization potential of their counterparties, according to Waite.

"Banks need to gain increased sophistication in this area—this is not a core competency of loan origination personnel at the moment," Waite said. "While the PBOC CERF incentivizes lending into certain sectors which foster decarbonization, it also creates a broader credit assessment skill set within the banks."

Posted 07 January 2022 by Max Tingyao Lin, Principal Journalist, Climate and Sustainability