Principles to catalyze impact from US green bank financing

December 4, 2022Twenty-seven billion US dollars in “green bank financing” through the Greenhouse Gas Reduction Fund (GHGRF) is intended to drive investment in solutions that reduce greenhouse-gas emissions and support investment in low-income and disadvantaged communities. Adhering to a set of impact principles can unlock the transformative potential of this funding, including focusing on where the benefits are greatest, galvanizing a distributed financing network, gaining optimal financial leverage, deploying a mix of financing vehicles to catalyze private investment, and mobilizing rapidly to meet 2030 targets.

To meet its net-zero target by 2050, the United States would need to quadruple its annual low-carbon investment, reaching a total of $9 trillion over this decade.¹ Almost half of the emissions reductions needed to reach the net-zero target come from a transformational and immediate shift in the energy system toward renewable-power generation and electrification of transportation and buildings.² Some of these emissions are geographically concentrated—ten states make up 50 percent of US power sector emissions, which are further concentrated in specific communities with large fossil-fuel power plants.³ Other emissions reductions depend on deploying a few key technologies (such as electric vehicles and heat pumps) at scale across communities. Crucially, much of the challenge lies in disadvantaged communities, where effective solutions are needed for those who are marginalized and overburdened by climate change and pollution, and who often lack access to finance and find many climate solutions unaffordable.⁴

As part of the response to this challenge, Environmental Protection Agency (EPA) will allocate $27 billion in Inflation Reduction Act (IRA) funding through the GHGRF for climate and environmental justice.⁵ As a complement to the broader IRA package, this funding includes $20 billion in competitive grants to eligible nonprofit financing institutions to address finance-related barriers to reduce or avoid GHG emissions (and other forms of air pollution) and to assist community efforts toward this goal through financial and technical assistance. At least $8 billion of the $20 billion in GHGRF funding is required to support low-income and disadvantaged communities, which face large unmet financing needs and lower access to capital and financial services. Recipients, either new or existing nonprofit organizations, can deliver financing directly or in partnership with intermediaries—the United States has a network of more than 20 state and local green banks and more than 1,300 community development financial organizations (CDFIs) focused on local lending and community development. The GHGRF also includes a further $7 billion set aside for  states, municipalities, tribal governments or other recipients to deliver financing and support for zero-emission technologies.

GHGRF funding could play a pivotal role alongside the broader IRA in bending the curve toward an inclusive net-zero trajectory. Five key impact principles can help achieve this potential:

1. Focus on technologies and communities where the benefits are greatest

Achieving impact depends on targeting financing toward technologies and areas that deliver significant emissions reductions and outsize benefits to disadvantaged communities. This means breaking new ground to deliver opportunities that achieve both emissions reductions and environmental justice and balancing between objectives where necessary. It may be challenging to maximize all goals for GHGRF funding in all investments, but by targeting these multiple goals in aggregate the funding can support high impact.

• Targeting financing toward technologies and geographies with the greatest potential for emissions reduction. This might mean focusing on region-specific challenges such as decarbonizing older buildings in the Northeast or coal-dependent power production in the Northeast and Midwest. It might include a focus on technologies such as transportation electrification that enable sectorwide transformation and are needed across the country. It might also include a focus on coordinating and enabling cross-state projects, such as transmission lines that are critical to the deployment of renewables, which are difficult to manage and may particularly benefit from at-scale capital.⁶
• Targeting support toward disadvantaged communities that have been most burdened by climate change, face specific investment challenges, or have been particularly underserved by traditional financial institutions.⁷ This could include explicit allocation objectives; for example, Cleveland’s GO Green Energy Fund targets low-income communities.⁸ It could also include the propagation of replicable investment models, such as the Solar for All programs across US states that support low- and middle-income households installing solar power.⁹

2. Galvanize a distributed financing network

Effectively deploying priority technologies depends on leveraging local knowledge and expertise, coordinating best practices and building publicly available resources to reach customers and accelerate demand. This includes coordinating an ecosystem that delivers technologies on the ground, and customizing financing to local circumstances, especially in disadvantaged communities.

• Working directly or in partnership with local institutions and intermediaries that have established relationships with end customers and with supply chains to deliver effective investment. This may include local CDFIs, alongside commercial financial institutions and businesses. This includes a range of interventions to build demand, such as grants or other funding for customer engagement and awareness building. For example, local green banks such as Michigan Saves and CDFIs such as Florida SELF have spent years building relationships with local contractor networks, landowners, and credit unions, gaining community trust, and helping drive deal flow.
• Skills and knowledge building across these local ecosystems to increase their effectiveness through resources such as standardized green-financing procedures and documents, replicable supplier agreements, and common metrics and technology infrastructure to monitor and evaluate impact. For example, the CDFI Fund provides technical assistance awards of up to $125,000 to build the capacity of CDFIs through hiring, training, and other activities.¹⁰

3. Gain optimal leverage from GHGRF funding

Deploying initial funding with appropriate and responsible leverage can increase the overall capital deployed and its impact. Private cofinancing, capital recycling, and a well-balanced portfolio can all support catalyzing investment at greater scales. However, obtaining the right balance of private sector leverage versus targeting additionality and targeting impact for beneficiaries will be important for achieving overall GHGRF goals. Optimal leverage will vary based on technology maturity, community needs, and the availability of complementary grant-based programs, with lower leverage ratios likely when investing in less established technologies or disadvantaged communities. Approaches may also need to balance short-term private leverage against longer-term market catalyzation goals.

• Co-investment and strategic use of risk-reducing instruments (such as guarantees) to directly crowd in private investment. This might include concessional terms for unsecured lending or underwriting real or perceived risks in the absence of a market track record. American green banks mobilized $1.7 billion in total clean-energy investments from $440 million of their own financing in 2020 alone.¹¹
• Efficient capital management and securitization of loans (for sale to private partners) to free up capital for new lending. This includes capital management to minimize undeployed capital as well as support for aggregation and securitization of smaller loans. These activities also pave the way for future securitizations in that asset class when scale is reached. Examples include the Hawaii Green Infrastructure Authority’s Green Energy Market Securitization Program, which reduces the cost of clean-energy loans to consumers through a rate-reduction bond structure.¹²
• Balancing less risky investments against riskier ones within a portfolio to promote financial stability while also supporting high-risk technologies and disadvantaged communities. This could potentially enable debt issuance while also affording room for lower returns or higher losses in some segments of the portfolio. In one approach, Australia’s Clean Energy Finance Corporation has built a lending portfolio that includes commercial-rate senior loans whose proceeds are explicitly used to cross-subsidize other concessional-rate lending programs.¹³

4. Deploy a mix of financing vehicles flexibly to catalyze markets at scale

Achieving transformational impact means green bank financing and its leveraged cofinancing must address key constraints to investment. This requires a focus on investment approaches and specialized knowledge that are continually at the forefront, removing the specific barriers to private financing – which can also leave behind the conditions for pure private financing in the future.

• Financing approaches to remove technology-specific challenges such as technology performance risk, construction and operational cost risks, lack of liquidity, and regulatory uncertainty and market immaturity. The United Kingdom’s Green Investment Bank invested in a series of offshore wind projects to tackle these risks at key stages in the deployment journey, accelerating competitive private financing of the sector.¹⁴
• Approaches to overcome access to finance challenges for low-income groups—for example, in relation to credit history, lack of collateral, mismatches between ability to pay and investment costs, and small ticket size. Various state and local green banks support the rollout of residential solar panels with on-bill payments as opposed to traditional loans, for example, and they have used targeted funding to bring down the costs of technology or borrowing.¹⁵
• Systematic learning and flexibility in how financing is allocated to support reprioritization of investment toward approaches with the greatest demonstrated impact and where additional public support is most necessary. This also involves ending financing where the private sector has stepped in. For example, the Connecticut Green Bank withdrew direct investment support for commercial property assessed clean energy (C-PACE) lending programs in 2015 as the market matured and private investors filled its role.¹⁶

5. Mobilize investment quickly

Given the scale and urgency of US plans to cut emissions by 50–52 percent by 2030, rapid deployment by recipients of funding would be needed to jump-start investment and the learning by doing that drives market transformation—while making sure not to leave behind communities that need more time to roll out investment at scale. Rapidly defining robust criteria and guidance for targeting and disbursing funds can support effective mobilization.

• Initially focusing funding on more advanced technologies and on helping existing intermediaries fund established pipelines of projects. For example, in its first year of operation, the UK Infrastructure Bank, established in 2021, initially focused on a mix of direct project lending and cornerstone investment in smaller funds that were ready to receive capital. In the United States, alongside the broader IRA incentive programs, green bank financing could potentially mobilize a large array of intermediaries, including retailers with existing customer campaigns.
• Offering funding commitments, like lines of credit or conditional grants, that rapidly enable a large number of partner intermediaries to advance financing opportunities without tying up capital before projects are ready for financing. Various multilateral development banks have built out finance facilities over the past two decades, demonstrating the power of such facilities to mobilize a large network relatively quickly. For example, the Green Economy Finance Facility of the European Bank for Reconstruction and Development reaches more than 140 local financial institutions across 26 countries.¹⁷

Done well, green bank financing can overcome critical barriers to investment, unlocking the power of private finance at a scale well beyond the initial funding. Numerous examples demonstrate the feasibility of best practices and their outsize impact. By adhering to the above impact principles, we believe GHGRF recipients can drive a system transformation. There is much experience to build upon, an urgency to bring together the best of the best, and more.

In early 2023, McKinsey will follow up on these principles with a quantitative assessment of the potential for GHGRF green bank financing to catalyze investments and support climate and environmental-justice objectives. The report will quantify the impact of this green bank financing across GHG emissions reductions, job creation, cost savings, and health improvements for disadvantaged communities and for the United States as a whole.

_{1. Navigating America’s net-zero frontier: A guide for business leaders,” McKinsey, May 5, 2022.}

_{2. The long-term strategy of the United States: Pathways to net-zero greenhouse gas emissions by 2050, US Department of State and US Executive Office of the President, November 2021.}

_{3. “Carbon intensity of U.S. power generation continues to fall but varies widely by state,” US Energy Information Administration, September 2022.}

_{4. Justice 40: A whole-of-government initiative, White House, accessed November 29, 2022.}

_{5. Inflation Reduction Act, Section 60103, “Greenhouse Gas Reduction Fund,” US Congress, August 2022.}

_{6. Transmission projects ready to go: Plugging into America’s untapped renewable resources, Americans for a Clean Energy Grid, April 2021.}

_{7. Climate change and social vulnerability in the United States: A focus on six impacts, US Environmental Protection Agency, September 2021.}

_{8. Peter Krouse, “Cleveland-based green bank in line for federal dollars to fight climate change in disadvantaged communities,” cleveland.com, August 24, 2022.}

_{9. Solar for All, New York State Energy Research and Development Authority, 2022; Solar for All, Washington, DC, Department of Energy & Environment, 2022; Illinois Solar for All, Illinois Power Agency and Elevate, 2022; Solar for All program, Connecticut Green Bank, 2022.}

_{10. Audit of the Community Development Financial Institutions Fund’s financial statements for fiscal years 2021 and 2020, US Department of the Treasury Office of Inspector General, December 2021.}

_{11. Green banks in the United States: 2021 U.S. green bank annual industry report, American Green Bank Consortium, May 2021.}

_{12. GEMS (Green Energy Market Securitization) Program frequently asked questions, Hawaii State Energy Office, November 2014.}

_{13. Clean Energy Finance Corporation annual report 2021–22: A decade leading Australia’s energy transition, CEFC, 2022.}

_{14. The Green Investment Bank, UK National Audit Office, 2017.}

_{15. Clean energy finance: On-bill programs, US Environmental Protection Agency, September 2019.}

_{16. “Greenworks Lending announces closing C-PACE transactions totaling $1 million,” Connecticut Green Bank, August 2015.}

_{17. About GEFF, Green Energy Financing Facility, European Bank for Reconstruction and Development, accessed November 29, 2022.}