Policy support and credit growth
Since 2017, China’s banks have been actively cleaning up their balance sheets, resulting in the disposal of trillions of yuan worth of nonperforming loans. Even as banks deal with a previous generation of bad loans, they are laying the foundations for a new wave of distressed debt in green finance.
The need for green credit clean-up solutions has its background in Beijing’s regulatory direction. In September 2020, Xi Jinping announced that China’s carbon dioxide emissions would peak by 2030 and that China would achieve carbon neutrality by 2060. Since then, low-carbon development and the green transition have been among China’s top economic priorities.
China’s banks have been at the vanguard of efforts to realize this vision. Over the past four years, the average annual growth of banks’ green loans has been greater than 30%, while overall banking-sector loan growth increased about 10% annually over the same period. By the end of September, green loans accounted for almost 14% of all outstanding bank loans—more than twice their level in 2020.
Regulatory incentives and green finance definitions
The rapid expansion in green credit has been fueled by implicit political and explicit regulatory incentives. A significant incentive is the inclusion of green finance in the PBoC’s quarterly macro-prudential assessment of China’s largest banks. Banks that regulators deem too risky can be docked points, while banks with active green lending programs can receive extra points.
Green metrics have been incorporated into banks’ MPAs since 2017, but green lending accelerated after Xi announced carbon targets in 2020. Policy banks and major commercial banks have announced large green-finance targets, and regulators have encouraged banks to increase green credit and develop green financial products.
Green finance is defined by the People’s Bank of China as financial services provided for activities that support environmental improvement, climate change mitigation, and efficient resource utilization. It includes support for green projects, climate-impact reduction, and regulatory-compliant environmental activities.
Green-washing and overcapacity risks
Many loans classified as green may not strictly meet the PBoC’s criteria. In the past, banks’ new loans mostly went toward home mortgages, housing and infrastructure projects, and manufacturers. More recently, a large share of new bank loans has been officially classified as green, creating a risk that loans made anyway are rebadged as green.
By creating a regulatory framework that encourages banks to lend for political reasons, authorities may have laid the foundations for the next generation of NPLs. Overinvestment in green businesses has already contributed to overcapacity in electric vehicles, batteries, wind turbines, and photovoltaic components. Without sufficient international demand, overcapacity could transform into distressed debt.
ShoreVest implications
In ShoreVest’s deal flow, opportunities are already emerging as a result of the trend toward sustainability. In 2020, ShoreVest participated in asset-backed bridge financing and debt restructuring for a fundamentally sound water-filtration systems manufacturer, exiting in approximately two years at a higher-than-underwritten return.
In 2024, ShoreVest provided asset-backed financing in renewable energy to a solar energy company, with the transaction expected to generate outsized credit returns and exit in less than a year. ShoreVest has also successfully reduced carbon emissions from underlying collateral across other asset-backed financings and restructurings.
Although evidence of a new wave of green NPLs has yet to appear in formal banking data, ShoreVest is already seeing early signs of greater need for credit clean-up solutions among sustainability-related assets.