Climate Bad Banks for Stranded Assets

Stranded assets are becoming a reality. Take the case of thermal coal. It is widely recognised that thermal coal is no longer a growth opportunity. This is coupled with the fact that debt financing grew sharply and leverage ratios have skyrocketed. A bulk of financing for thermal power plants has come from debt. With thermal power plants being rapidly replaced by renewable energy plants, many power plants will become defunct. Given that there is a large amount of debt associated with these plants, the lenders are in a quandary.   

Image by jwvein from Pixabay

So, what happens to these power plants? Creating a climate “bad bank” could be better than running down these power plants.   

The idea of a bad bank has gained currency with the Non-Performing Assets (NPA) of Indian banks. A ‘bad bank’ is a bank that buys the bad loans of other lenders and financial institutions to help clear their balance sheets. Over time, the bad bank resolves the bad assets. Like the concept of bad banks, there can be climate bad banks that cater to assets impacted by climate issues.  

There are four ways in which resolution can occur:  

On Balance Sheet Guarantee: Here, the bank protects part of its portfolio against losses, typically with a second-loss guarantee from the government.  

Internal Restructuring unit: A separate unit is created in this scheme, and the assets are placed within it. This ensures sufficient management focus and incentives are aligned to the restructuring of assets bringing about efficiencies.  

Special Purpose Entity: This is an off balance-sheet solution. Here the unwanted assets are offloaded into a special purpose entity (SPE). This way the assets are taken off the balance sheet.   

Bad Bank Spinoff: In the spinoff, the bank shifts the assets off the balance sheet and into a legally separate banking entity.  

Creating a bad bank is desirable action. Without a bad bank, the fossil fuel assets may be sold off to opaque unlisted entities. These entities may have little or no intentions of running or responsibly closing these assets.