Indian banks find interest in: UNEP Solar Loan approach.

IN LESS THAN THREE YEARS, almost 100,000 people in rural areas of southern India obtained clean and reliable electric power because of one main reason: their family could get a loan from a conventional bank that was previously unavailable. More than 16,300 families were part of the Indian Solar Loan Programme of the United Nations Environment Programme (UNEP), which has been working with the finance sector for some time on new approaches to finance renewable energy.

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The loans for the photovoltaic solar home systems (SHS) came from Canara and Syndicate Banks, two of India's leading financial organizations. There was no capital subsidy, but instead an innovative interest-rate subsidy that allowed the banks to feel more secure about increasing their lending services for a technology that they had not previously considered financially attractive. India's expanding solar industry has a potential market that includes 65 per cent of rural house-holds, which do not have access to a reliable electricity supply. These households may have access to electricity, which is often unreliable, but many rely on kerosene for light, and on dung and wood for heat--poor-quality energy that impacts their health from respiratory diseases and limits their economic and social development.

Without financing, however, the high initial cost of an SHS constrains the growth of the Indian market. Increased access to credit can enable rural households to buy cleaner energy services and pay for it with the money they are spending on less efficient and often more polluting forms of energy (see table above). India has a well-developed rural banking infrastructure, but the links to the renewable energy sector have been weak at best.

The main objective of the loan programme is to help Indian banks develop lending portfolios targeted to solar home systems in poorly supplied regions of South India. Research shows that without such programmes poor households in rural and semi-urban areas bear the brunt of power shortages and have limited access to better and more expensive alternatives. These programmes also contribute to the Government's efforts to increase local Grameen Bank financing of self-help groups (SHGs), the Indian version of micro-credit lending, whose potential customers are households and small enterprises looking to use SHS for either domestic or income-generating activities.

During the first phase of the programme, many diverse stakeholders were consulted, including SHS vendors, banks and other small-scale financing institutions, governmental agencies, experts and non-governmental organizations. Such consultations provided significant input on the state of the solar industry in South India, the need for SHS financing and the best mechanisms to influence growth of such financing. Although the banks had sufficient capital and were generally seeking to develop new loan facilities, they were not ready to treat SHS loans as a standard product in their lending portfolios. The combination of the newness of the technology with the quality of product or service offered made SHS lending difficult for banks, although some, to their credit, agreed to experiment and explore the potential for increased lending.

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After consultations with three southern Indian States, Karnataka was initially chosen. Partnership agreements were signed with Canara and Syndicate Banks, both of which have networks of rural branches in most parts of south India; Canara Bank, for example, launched the project from 300 branches in Karnataka. These innovative banks have a deep reach into rural areas and provide credit to poor households through SHGs, in large part through their own networks and sponsored regional rural banks or Grameen banks.

The right finance intervention model has several dimensions: it encourages the market to grow and vendors to innovate their products and services; it does not substantially distort the market; and it includes a predetermined exit strategy. Capital subsidies have a tendency to "stick" and distort the true price of SHS in the market. The necessity for a loan-guarantee facility was also ruled out, since the banks were willing to take the loan's full-credit risk. Both banks pushed for an interest-rate subsidy that would enable them to offer preferential banking terms to their customers in an efficient and transparent manner, although they would not benefit directly from it.

The subsidy--an interest rate "buy-down"--allowed partner banks to offer consumer loans at interest rates that were initially 7 per cent below the prime lending rate of 12 per cent. This mechanism reduced the amount of subsidy needed per system and has been used successfully in the Indian renewable energy sector. It has also been used in solar water-heating systems by the Indian Ministry of Non-conventional Energy Sources (MNES), as well as in the solar photovoltaic sector on a small scale directly by Selco, one of the leading solar vendors.

The incentive applied as an interest-rate subsidy was a small share of the total financing, with banks providing most of the capital and carrying 100 per cent of the credit risk (risk of default). These banks were thus motivated to maintain quality-loan portfolios. Price distortion was also minimal because the cost of finance, not capital, was subsidized. By providing loans with an interest rate buy-down, both the "high upfront cost" and high credit cost barriers were addressed.

An important element of such schemes is the exit strategy, which can be simple and straightforward for interest subsidies. As loan disbursements increase, the subsidy can be progressively phased out to leave the market on commercial terms at the end of the programme. This is a unique feature of the UNEP initiative, with its interest rate for SHS the same as the market rates. Rather than work through public tenders, UNEP decided to offer the programme to all vendors that could meet a set of product-quality and after-sales service criteria, and to keep the qualification process open for new vendors to apply over time. Product quality and pricing were, therefore, mostly set through competitive forces, not programme regulations.

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The alternative was direct tendering with a "winner takes all" lowest bidder. However, when one vendor is chosen over the others, a market where a number of experienced companies are already doing business can easily be distorted. Although it might drive the prices down in the short term, tendering generally reduces the number of active vendors and does little to promote long-term, sustainable markets. It is better to design a programme that builds off the leadership of market innovators, such as Selco, but in a way also allows all credible vendors access to these new credit markets.

Canara Bank began to offer their new SHS loan product in April 2003, while Syndicate Bank started its programme slightly later, in June. An initial SHS loan target of 5,000 systems was set during the first two years, with over 16,300 having been financed as of 31 March 2006. The subsidy has been fully removed from one bank and is in the process of being removed from the other. The credit market has responded well to incentives, with 50 per cent of all SHS now financed, compared to almost none in 2003. The biggest success, however, is the more than 20 banks that have launched competitive loan schemes for SHS outside of the UNEP programme, resulting in increased sales.

The future of the solar photovoltaic industry in South India looks promising. The banks have set very ambitious loan portfolio goals and have been working to achieve these targets. Interestingly, the level of "total" subsidy provided through the interest subsidy is much less than with other approaches, and yet the banks are mobilizing. This is a good lesson for the development of future programmes, which can determine the overall positive (or negative) impacts. UNEP has used the success of the Indian Solar Loan Programme to expand into other areas, including solar water-heating loan programmes now underway in Morocco and Tunisia. The programme, of course, is not a panacea for the photovoltaic sector, but it is one approach that will be needed to drive markets towards a greener energy sector.

Support for the Indian Solar Loan Programme has been provided by the United Nations Foundation and the Shell Foundation in cooperation with the United Nations Fund for International Partnerships (UNFIP). For more information, visit http://www.unep.fr/energy/act/fin/india/index.htm.

Jyoti Prasad Painuly (left) is working with UNEP Risoe Centre, Denmark, as a senior energy planner. His areas of interests include renewable energy, energy efficiency and policy, and climate change issues.

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Eric Usher (right) heads the Renewable Energy and Finance Unit at UNEP, working to engage the finance sector in the shift towards cleaner energy infrastructure.

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This is part of a series of articles exploring the many facets of partnerships supported by the United Nations Fund for International Partnerships (UNFIP). In the series, some of the UN private sector and foundation partners will convey their views on how partnerships with the United Nations are being built and are achieving impact on the ground.

Monthly Costs in Rupees for a Household with 4 lights*

               Existing Grid  New Grid
Period         Customer       Customer  Kerosene  Inverter  SHS

first 5 years  115            297       212       465       325
10 years       148            298       272       465       200

* Economic and Financial Assessment of SHS for the State of Karnataka,
Crestar Capital, March 2002. Figures include some tariff increases.