Sunshine is a global public good. But while sunshine itself doesn’t cost a penny, it does cost to convert it into usable electricity, making affordability a challenge for many households.

Adoption has remained slow-paced and restricted to affluent neighbourhoods. Unless there is a way to wrap the rooftop solar offering in an affordable financing package, the uptake will continue to be limited.

To address solar financing, the State Bank of Pakistan (SBP) introduced Financing Scheme for Renewable Energy in 2006. The scheme required banks to finance renewable projects at a subsidised end-customer rate of up to 6 per cent per annum.

The banks would get refinance on all such loans from SBP at 2pc and then lend onwards at 4pc spread for a maximum of 10 years. The scheme defined two categories of customers, based on the purpose and size of the energy equipment.

The first category covered large 1 megawatt (MW) to 50MW plants, while the second category (which includes domestic/residential, commercial and industrial customers) addressed system buyers of up to 1MW capacity.

The scheme, expiring this month, despite offering generous incentives failed to trigger meaningful adoption of renewables. Barring a couple of transactions for large industrial systems, the financing limits for the banks lapsed unutilised.

The problem is that customers won’t take solar loans against collateral while banks find clean lending untenable under the existing conditions

The financing for residential rooftop systems (under category 2 of the scheme) was almost nil. A new scheme with similar financial incentives is due to be announced soon by the SBP. However, unless the real issues are addressed, the new scheme too is expected to meet the same fate.

Banks struggle with two key challenges in doing clean (collateral-free) lending for solar. Their first challenge relates to the lack of a secondary market for solar equipment.

Unlike automobiles, the market for second-hand solar equipment is not that well-developed. So banks are reluctant to accept the financed solar equipment (underlying asset) as collateral and instead require additional security in the shape of cash or property.

Due to the lengthy/expensive process of establishing a mortgage over property, customers find these solar loans unattractive despite their subsidised financing cost.

Then, the lack of contract enforcement in the event of a customer default is another reason why banks hesitate in offering clean loans. Banks fear that they would be unable to repossess the financed asset in case the customer defaults on his payments.

The problem is thus clear: customers won’t take solar loans against collateral while banks find clean lending untenable under the existing conditions.

The government can take multiple steps to address these issues. Firstly, the SBP should allow a higher spread to banks for clean lending under the new scheme. A higher spread, of say 6pc, would be attractive enough for banks to compensate them for their increased credit risk.

At the same time, an 8pc clean financing rate on solar systems would still be acceptable to customers. It is pertinent to note that this would cause no additional burden to the government since SBP’s refinance rate would remain the same (at 2pc) and the entire credit risk would be assumed by the banks.

Secondly, on the issue of asset recovery, while the system’s repossession from customer’s premises would remain a challenge, there are certain solar vendors that provide the technology allowing the lender to disable the functionality of the installed solar system.

In this context, the risk of default could be significantly reduced if the utility (the relevant electricity distribution company) is made a party to the financing contract/loan agreement.

Thus, in the event of a customer default, not only does the solar vendor disable the solar energy system, but also the electrical connection from the grid is cut off.

The consumer is left only with any back-up source of power that may be in place. This utility company could also become the collection agent for the loan repayments and charge a fee for this which could form its additional revenue stream.

With their revenue and collection assured, the banks would not only be able to lend longer tenor loans but will also be willing to fund Power Purchase Agreements (PPA) between the solar vendors and customers. A PPA entails a solar vendor to sell electricity at a lower-than-grid rate for a period of more than 10 years.

This way the customer doesn’t have to invest in the system and just make monthly payments for the units generated by the rooftop system. Depending on the contract terms, the system’s ownership can transfer to the customer at the end of the PPA term.

Thirdly, the government should set up an organisation (public, private or funded by multilateral donor agencies) that can provide default risk insurance to the lending banks.

The insurance premium would be paid by the customers but could be substantially minimised if the utility is made a party to the loan contract.

Lastly, in addition to the provision of default risk insurance, the government may also consider setting up a green fund. The government could be a contributor to the fund along with local commercial banks, World Bank, Asian Development Bank, as well as our major economic partners such as UAE, Saudi Arabia, Malaysia and China.

Since China has a dominant position in renewable energy products, the fund can be made part of CPEC. Here the incentive for China would be to ensure a bigger market for its renewable energy products.

They have a very large manufacturing base of companies whose target market would increase if there was an easier path to the millions of homes that can benefit from both on-grid and off-grid solar solutions.

The goal would be to fund a certain number of low income neighbourhood homes and small businesses (say first 100MW or first 10,000 customers) with solar solutions. This could be a pilot fund that can eventually become the basis of additional funds over time, to unlock the very substantial multi-gigawatt market.

These measures will not financially burden the government by much but would go a long way in opening up the solar rooftop market for households who are unable to bear its high upfront costs.

This ‘solar inclusion’ would thus not only improve our energy resilience but would also ensure that the sun doesn’t only shine for a fortunate few.

The writer heads the business advisory function at a large industrial and services group in Islamabad

Published in Dawn, The Business and Finance Weekly, June 3rd, 2019