No Good Deed Goes Unpunished: Green Investment Bonds Are Credit Negative For Banks

When European Commission (EC) Vice President Valdis Dombrovskis announced an array of green investment proposals to encourage capital formation in green investment bonds – including lowering capital requirements regulators will allow for such investments – this intervention is viewed as a negative, according to Moody’s. While the overall goal to more closely conform with the Paris Agreement is viewed as a consistent policy statement from the European Parliament (EP) – and encourages investment in a geopolitically strategic industry — it is not a credit positive for the banks, Moody’s analyst Alberto Postigo says.

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Green Investment Bonds
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Green Investment Bonds: As the strategic battle for green jobs is being fiercely fought by China, the European Union looks to encourage investments

“Green jobs” and green investment is not just a social imperative, but have become a global race of sorts.

While employment related to renewable energy in the US is growing, with 260,000 people employed in the sector, in China 2.5 million people are employed in green energy, according to the International Renewable Energy Agency.

"Even in China where coal is -- or was -- king, the government still recognizes that the economic opportunities of the future are going to be in clean energy," Alvin Lin, Beijing-based climate and energy policy director with the Natural Resources Defense Council, told CNN.

In Europe, there is a recognition that engaging in green energy planning is good for the long-term economy -- and they are taking action.

The proposed EC incentives come as the European Parliament (EP) proposes to support “green” industries by reducing risk weights on such investments by 24% for investments for those below €1.5 million and 15% for the portion above €1.5 million. Investments secured by residential property would not be eligible.

Moodys noted that to determine which investments qualify, the EP would create a Climate Bonds definition that would not be combined with other social initiatives designed to influence investments, such as supporting small and midsize enterprises or infrastructure.

“Introducing a green-supporting factor would stimulate green investments and financing instruments in Europe, including green loans and green bonds from financial institutions,” Moody’s predicted.

Buying Green investment nonds comes at a cost

But while the government creating investment incentives might be positive for those companies involved in green initiatives, it might create a risky situation for the banks.

Positive government social policies often come at a price. In Europe, a region known for government intervention in the workplace and environment, the government encouraging investors to provide incentives to green assets will have a market impact: It will weaken the credit profile of those managing such investments because “the lower capital requirements would likely lead banks to hold less capital for exposures that feature similar risk characteristics as traditional loans or bonds.”

While the green investment bonds program might achieve the goal of encouraging green investments at a time when China is taking the worldwide lead in this regards.

“The green-supporting factor would contribute to European policymakers’ objective of stimulating environment-friendly financing and investments, but could weaken banks by establishing capital requirements that underestimate the real risk of green assets, a credit negative,” Postigo wrote in a December 18 report. “The credit implications for affected banks would be negative, because the lower capital requirements would likely lead banks to hold less capital for exposures that feature similar risk characteristics as traditional loans or bonds.”

But not only will the program lead to sub-par financial engineering, but it might also encourage immature products to come to market, Moody's says. "Green investments may be in immature technologies not sufficiently tested or that can be quickly surpassed, and are exposed to high obsolescence risk," the report noted. "Policy and regulatory risk – for instance, changes in subsidies or carbon pricing and taxes –also will affect asset quality." This could result in defaults. "For banks, such challenges would translate to a heightened risk of credit losses."

No good deed will go unpunished.