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By Labanya Prakash Jena and Uma Pal
India’s housing sector presents a great opportunity for climate action
Indian homes contribute significantly to the country’s greenhouse gas (GHG) emissions. This sector alone creates more than 20% of India’s total emissions, primarily through electricity consumption. What’s more, electricity use for cooling Indian homes is expected to increase due to rising temperatures and heat waves.
With a rapidly growing urban population increasing the country’s housing demand, immediate action is needed to prevent the sector from becoming a major obstacle to achieving national climate goals.
Challenges in adopting and scaling green housing solutions
Green housing appears to be a low-hanging fruit to help achieve India’s low-carbon pathway. However, the country currently lacks an enabling ecosystem to help scale green housing, with limited economic incentives for both borrowers and lenders.
Green buildings require higher initial capital than traditional ones due to higher costs incurred for the design, sourcing, construction, certification, and maintenance of green materials and features such as rooftop solar, green roofing, and rainwater harvesting systems. Commercial banks have been reluctant to provide enhanced loans to cover the additional capital requirements of green homes, given that their loan-to-value ratio would increase.
However, green homes can offer significant financial benefits, such as reduced energy and water costs over the lifetime of the assets. In addition, by using passive designs to reduce indoor temperatures, green homes can be beneficial for households that cannot afford to buy expensive and carbon-emitting air conditioners.
However, prospective buyers in the buy-to-rent segment have less financial motivation to purchase green properties, as it is the tenants who will benefit from any resulting energy cost savings. Retrofitting green solutions in existing housing also remains challenging, as borrowers rarely wish to use their houses as collateral in order to borrow from banks to finance such retrofits.
An increased policy push, awareness raising, and mainstreaming of green solutions are needed to accelerate the adoption of green housing.
Commercial banks’ approach to incentivizing green housing
In this context, banks, including the State Bank of India, Axis Bank, and Maharashtra Bank, offer discounts on prevailing interest rates to incentivize the uptake of loans for green homes. Reduced interest rates for green housing projects will benefit builders who follow environmentally friendly practices and buyers who purchase green homes. This can lay the foundation for mainstreaming green building considerations in urban planning and development.
What more can be done to scale green housing effectively
A few key actions that can be taken by the actors in the financial sector to scale green housing are outlined below.
- Increasing loans for retrofitting: While banks provide loans for new green housing, such incentives can also be expanded to include discounts or other forms of encouragement for green retrofitting of existing housing. For example, omitting the current requirement of providing an entire house as collateral for a new loan can incentivize borrowers to retrofit their homes with green technologies.
- Higher loan-to-home value: The higher capital costs of green construction vis-a-vis standard buildings can be covered by increased borrowing. Subsequent savings from reduced energy consumption or the use of renewable energy can then be used to cover the additional debt burden. Reduced energy costs can also raise the collateral value of green buildings, thereby lowering the credit risks associated with such housing.
- Insurance: A critical risk for borrowing for green building construction is the potential for energy efficiency savings to fall short of expectations. Developers (or households in the case of independent homes) may depend on these cost savings to repay their green construction loans. Energy performance insurance guarantees can be introduced for property developers to purchase prior to construction and claim against if energy savings fall short of expectations. The central government may consider subsidizing such insurance for homes for low income households under the Pradhan Mantri Awas Yojana scheme. Enabling energy savings for poorer households is prudent for the government, as this will reduce its electricity subsidy burden as well as supporting the country’s green transition.
- Lower risk weightage: Commercial banks are demanding lower cash reserve ratio (CRR), statutory liquidity ratio, and risk weight on green loans than similar traditional loans, decreasing the cost of capital for green assets. Although it is unclear whether all green assets have lower financial risks than similar conventional assets, empirical studies indicate that green buildings have lower credit risk than traditional ones[1],[2] India’s central bank can incentivize commercial banks to reduce risk weight and CRR for green buildings, further encouraging their uptake.
- Carbon credits from green homes: Finally, generating and monetizing carbon credits from the construction and retrofitting of green homes can further incentivize sustainable building practices. A comprehensive mechanism and approach for creating, aggregating, and selling carbon credits can generate additional revenue from green buildings. This can help to scale green housing solutions from the demand side by creating the potential to reduce net equated monthly installments (EMI).
A win-win scenario for banks and borrowers
From the perspective of banks, green buildings create new lending opportunities and the chance to reduce climate-related financial risk in their loan portfolios. Improving climate-risk management practices will be increasingly important for banks as disclosure of financed emissions is gaining clout.[3] Given that loans for commercial and residential housing make up around 17% of total bank credit in India[4], banks can significantly reduce financed emissions by greening their lending for housing.
Favorable financial regulation and policy can help to make green housing financing affordable and attractive for both borrowers and lenders.
[1] https://iopscience.iop.org/article/10.1088/1755-1315/647/1/012146/pdf
[2] https://www.ifc.org/content/dam/ifc/doc/mgrt/59988-ifc-greenbuildings-report-final-1-30-20.pdf
[3] https://www.orfonline.org/research/assessing-rbis-draft-disclosure-framework-on-climate-related-financial-risks#:~:text=Asset%2Dlevel%20financed%20emission%20can,more%20accurately%20assessing%20transition%20risks.
[4] RBI Database