The RBI has announced a framework on the issuance of green deposits to be offered by banks. From a regulatory standpoint the main issue is on the use of such funds, as this requires proper targeting and monitoring. The guidelines are quite exhaustive and ensure that funds raised by banks in the form of green deposits are used for the desired purpose.
In fact, there will be third party verification reports as well as impact assessments to ensure proper use of funds. The challenges really now are on raising such deposits.
Simply put, banks can offer ‘green’ deposits that can be used for lending to sectors which qualify in the list put out by the RBI. Till such time the RBI draws up a taxonomy in this regard, banks will have to go by an illustrative list of industries, prepared by the RBI, which qualify for lending.
We have had green bonds issued by both banks and the government in the past which are supposed to work in a similar manner and the RBI guidelines presumably will form the template for the government too when it comes to deployment. But should an individual put money in a green deposit?
The question is relevant because of the issue of pricing. When it comes to the return on a green deposit, from the theoretical standpoint, the interest rate should be lower than that on a regular deposit.
This way, when lending such funds, the borrower who helps to green the economy will stand to benefit, which helps the national cause. However, this may not make much sense to the deposit-holder who typically seeks higher returns on savings.
If the deposit-holder is an individual, the rate of interest is most important when choosing the bank for investing funds. There is no reason for the individual who is today struggling to get a high return to compromise on the same.
Even in the case of bulk deposits which are essentially made by corporates, a green deposit that offers a low return will make sense only if there are regulatory set-offs. This set-off can be a case of such funds qualifying for CSR in some manner. Alternatively, if the government gives tax concessions to one and all, then they will be attractive.
However, today the government is in the mode of withdrawing all such tax benefits in the name of establishing a level-playing field for all savings and investments.
Therefore, to think that such a benefit will be given is out of place. Also, given the way in which tax benefits on capital gains have been treated, one will be apprehensive of a withdrawal at a later date even if offered today even in the absence of a sunset clause. Hence, the tax angle does not appear to be feasible.
It may be recollected that the government’s green bonds were placed at a yield which was just around 4 basis points (bps) lower than the regular 10-year bond as the market was not willing to pay a higher price or accept a lower yield.
The government had expected a much lower cut-off yield. A reason could be that this was the first experiment and the market was not quite ready on how to react to such bonds Therefore, at the institutional level if the green bonds were not very alluring, there is less reason to expect them to click with the retail deposit-holder who is seeking the highest return.
If tax benefits are not possible, then banks have to offer higher rates to garner funds. But it has been seen that every time a bank offers a higher rate on a specific maturity, deposit holders are almost automatically attracted to these buckets.
There can then be a case of most of the incremental deposits flowing to the green deposits that offer higher returns.
In such a case banks have to probably think of capping such deposits, else there will be large scale migration to this area where deployment is still practically a grey area. If done, this will probably be the first time that banks will have to impose a limit on deposits to be accepted. But offering higher rates and getting a good flow of deposits will run the risk of there not being enough deployment avenues due to lower demand.
Going deeper, a question that can be posed is whether we need to have a separate category of green deposits. If banks were very keen to lend for green purposes, they could just set aside a certain proportion of their outstanding deposits as of the previous year as those which will be directed to green projects.
This would be a better way to earmark funds for deployment in green projects. The only problem here would be that the banks will have to take a cut in spread which can be a deterrent.
Again to make this scheme feasible, the government may have to step in to provide some kind of interest rate subvention on green projects. Or such lending can be made part of priority sector loans. Is the government willing to do so?
There are hence a plethora of issues that need to be addressed in the course of developing a green market for both deposits and loans. The major issue is pricing.
When it comes to ESG funding, investors who care about the environment do not mind lower returns if the business saves the planet, but when it comes to the micro level, interest can be limited in the absence of incentives being offered. It could hence become expedient for the government to seriously consider giving some sops to make them attractive.
Market forces at play
Sovereign green bonds still find investors as it is a captive market. However for green deposits, it will be pure market forces at work, which will test the pricing mechanism relentlessly.
All new ideas surely begin with scepticism, and with time such apprehensions would be allayed. The step is hence progressive but will have to be fine-tuned to market requirements to become scalable.
But then, as the adage goes, any new venture which is well begun is half done and one can be sanguine of the prospects.
The writer is Chief Economist, Bank of Baroda. Views are personal