Instrument Overview
A commercial loan is a debt-based financing mechanism between the municipality and a financial institution such as a bank used to fund capital expenditures and operating costs. The loan is made available at market rate. Many commercial loans require a good credit rating and/or collateral in the form of municipal assets. Municipalities with a larger revenue base are more attractive to commercial banks (ESMAP 2014). Public funds available at national, state or regional governmental levels vary from country to country and can range from limited budgets to non-existent capital. Therefore, municipalities with a larger revenue base are more attractive to commercial banks (ESMAP 2014).
Why it matters for cities
- Municipalities can access capital with commercial loans from banks.
- Municipalities can combine this model with others (e.g., revolving fund)
Key features
- Loan Terms & Repayment: Medium- to long-term with structured repayments; may include grace periods.
- Interest Rates: Fixed or floating, based on credit risk and market conditions.
- Security & Guarantees: May require collateral or guarantees from higher-level governments or third parties.
- Use of Proceeds: Earmarked for specific climate projects; disbursed in phases tied to milestones.
- Compliance & Monitoring: Includes financial covenants, ESG criteria, and regular reporting requirements.
How It Works
- Parties Involved: Municipality (borrower), commercial bank (lender), contractors, and possibly guarantors (e.g. development banks or national gov’t).
- Funding Flow: Bank disburses loan funds to the municipality (often in stages); municipality pays contractors to implement the climate project
Benefits & Challenges for Cities
Benefits
- Commercial debt funding is usually cheaper than equity.
- Doesn’t require a sophisticated market.
Challenges
- Usually requires collateral or some form of guarantee.
- There can be limited understanding of green investments from the side of banks, especially exacerbated by the low creditworthiness of some municipalities, therefore leading to reluctance to appraise projects, or high perceived risk, which in turn increases the cost of capital.
Use Cases
Guaranteed loans from the Lithuanian Energy Efficiency Fund
The Lithuanian Energy Efficiency Fund (ENEF) was established in 2015 by the Ministry of Finance, the Ministry of Energy, and the Public Investment Development Agency (VIPA) of Lithuania. The ENEF channels ESIF finances into the renovation of central government buildings and modernisation of street lighting. For street lighting projects, it provides guarantees for commercial bank loans and decreases municipal costs.
The ENEF is managed by VIPA, which is wholly owned by the Ministry of Finance. VIPA manages the application process for guarantees, collects fees, and pays compensation. The Ministry is a shareholder and member of the supervisory and management boards of the ENEF (Vaskelienė 2015). If municipalities and municipal companies are interested in applying for a commercial bank loan or contracting an ESCO, they may apply for an ENEF guarantee. The ENEF assumes these obligations and compensates commercial banks for losses if, in the former case, an applicant cannot repay the bank for the loan and/or loan interest, or, in the latter case, cannot pay the ESCO.
The fund manages €79.5m, of which up to €14.5m is earmarked for the street lighting financial instrument. For the latter, ENEF offers an 80% guarantee of eligible costs for a timeframe of up to 20 years. The guarantee fee payable by the applicant to ENEF typically depends on the applicant’s creditworthiness, but is waived for municipalities and municipal companies (Balčiūtė J. pers. com.). The public guarantee allows commercial banks and ESCOs to provide more favourable loan and contract conditions to municipalities. In order to apply for the guarantee, the applicants must attach documents including an energy audit or inventory and an investment plan. If municipalities contract an ESCO, the model should comply with the criteria for public-private partnerships defined under the law.
Demand for such funding is very high: by the end of 2015, applications for street lighting funds had reached €95m, well over the €14.5m available through the fund (Vaskelienė 2015). As of April 2017, the fund had approved two street lighting projects, with two more under evaluation and six more in the initiation stage for a 50% investment guarantee from ENEF (Lauruševičienė 2017).
When to Use It
- If a municipality has a positive credit record, any of its projects can be financed under this model.
- The projects financed should be financially sustainable infrastructure projects of various sizes.
References
- ESMAP. 2014. "Financing Municipal Energy Efficiency Projects."
- Vaskelienė, Kristina. 2015. “Financial instruments in Lithuania: Energy efficiency”. (VIPA and European Commission Report). https://www.mmr.cz/getmedia/a8cee146-f59c-4e0c-988c-3b02977e0f18/Prague_20151019_VIPA_EE.pdf
- Lauruseviciene, Vaida. 2017. “Lithuanian experience on financing instruments for energy efficiency”. (VIPA).