A market in its infancy; with vast growth opportunities in the coming decade

The green finance business is rapidly expanding in China, as regulators are committed to achieving a greener economic transformation on top of the 2060 carbon neutrality goal. Green loans and green bonds, as the major forms of financing, accounted for only 8.3%/0.8% of the system's total credit portfolio in 2021. In our base case, we expect green loans/bonds to evolve into a Rmb62trn/Rmb8trn market in 2031E, implying a 10- year CAGR of 14.5%/ 22.2%. The green credit business could become a major revenue driver for banks, with a potential revenue pool of Rmb1.4trn and contributing to 15% of the banking system's total in 2031E. Other green finance products, like ESG funds and green insurance, may also grow rapidly due to the considerable unmet credit demand from green projects. In this note, we delve into the industry's regulatory dynamics, the evolution of financial products, the competitive landscape and potential beneficiaries.

More direct incentives and broader green definitions likely ahead

To facilitate green lending, the People's Bank of China (PBOC) included green finance in banks' quarterly macro prudential assessments. So far, the financial incentives mainly centre around reducing banks' funding cost. For example:

  1. Green assets are accepted as eligible collateral for re-lending facilities;
  2. The PBOC rolled out the carbon reduction emission tool.

The Rmb2.5trn annual funding gap the NDRC identifies for green projects will likely call for more stimulative policies. Reducing green assets' risk weighting may be a possibility. However, green finance has a narrower definition in China than abroad. We expect regulators to gradually broaden the scope of green industries and green lending, which could invigorate the green finance market.

Green lending

Green lending is generally a profitable business, with average ROA/ ROE of 1.33%/ 16.16% at present (versus 0.71%/ 8.56% for corporate loans). However, lower loan yields and deteriorating asset quality may be downside risks for profit margins. The national service risk of lower loan pricing to shore up the green industries may weigh on the net loan spread, particularly for the big-4 SOE banks, China's major green lenders. Currently, it is common practice for SOE banks to offer 30-50bps interest rate cuts on green loans, according to our discussions with banks' senior management.