The Green Investment Bank - Environmental Audit Committee Contents

Written evidence submitted by KfW Bankengruppe

KfW Bankengruppe gives impetus to economic, social and ecological development worldwide. As a promotional bank founded 1948 under the ownership of the Federal Republic and the Laender (federal states), it offers support to encourage sustainable improvement in economic, social, ecological living and business conditions.

KfW's domestic business in the areas of small and medium-sized enterprise, entrepreneurship, environmental protection, housing, infrastructure, education finance is done under the brands "KfW Mittelstandsbank" (SMEs), KfW Privatkundenbank" (private individuals) and "KfW Kommunalbank" (municipalities)

On top of that KfW is active in international project and export finance. This business is done through KfW IPEX Bank, a 100% subsidiary of KfW which is commercial bank in competition with other commercial banks. Development cooperation is done within KfW as a specific mandate on behalf of the German government within the brand "KfW Entwicklungsbank" (development bank).

KfW has a balance sheet total of 400 billion Euro as per 31 December 2009. Total Commitments in 2009 amounted to 64 billion Euro.

Environmental and climate protection is a major promotional priority. Therefore, KfW focuses on investments in renewable energies and energy efficiency in housing and SMEs. Commitments in this sector in 2009 were up to 20 billion Euro. KfW Bankengruppe is one of the world's biggest financing institutions for energy efficiency and renewable energy.

When answering to the following questions we refer to KfW's domestic business since this is the bulk of KfW's activities.

1.  The KfW "business model"

KfW's business model in the domestic business is specifically designed to combine promotional/policy goals with market elements. The latter is achieved by providing financing through the commercial banking sector.

In order to take out a KfW loan a customer has to get in touch with a commercial bank first. The commercial bank assesses the project and the creditworthiness of the potential final borrower, negotiates collateral and checks compliance of the project with the terms and conditions of a KfW promotional program. In case of a positive assessment by the commercial bank, the bank presents the project to KfW. KfW checks eligibility of the project within the promotional program and provides the commercial bank with a refinancing loan.

The refinancing loan to the bank is only extended if the project fully complies with the terms and conditions of the respective promotional program. Eligibility criteria touch on eg the type of investment/costs, the size of the company. KfW funds itself in the capital market based on its AAA rating. The AAA rating is an essential precondition for KfW to be able to extend the refinancing loan at a preferential interest rate.

On the basis of the refinancing loan including its terms and conditions, the bank extends the loan to the final borrower. Any advantage which might be included in the refinancing loan is thus passed on to the final borrower. This procedure of channelling KfW funds through the commercial banking sector to the final borrower is known as "on-lending".

In the standard on-lending model KfW assumes the credit risk of the commercial bank, while the commercial bank assumes the credit risk of the final borrower. In order to cover this risk, as well as administration cost the commercial bank is allowed to charge a credit margin which is set within a framework determined by KfW. In case of default of the final borrower, the commercial bank has to repay the refinancing loan to KfW.

In addition to this basic onlending model, KfW has introduced elements of risk assumption for the benefit of the commercial banks, ie KfW provides partial cover for the final borrower's risk in some instances.

2.  In what areas does the bank provide finance / who decides what areas to provide financial support to?

In its domestic business KfW provides financing in the areas of small and medium-sized enterprise, entrepreneurship, environmental protection, housing, infrastructure and education finance.

The areas in which KfW is active are clearly stated in the KfW law, which is the basis for everything KfW may do. Within this framework KfW may at its own discretion support specific areas eg stress promotion of energy efficiency, environmental protection and climate change.

Nevertheless, there is of course an ongoing dialogue with the German government KfW's activities as KfW's mission is to support the German Government's policies in the areas stipulated in the KfW law.

3.  How does KfW raise its funding?

KfW covers its borrowing needs basically in the national and international capital markets. In 2009 KfW raised long-term funds in the equivalent of roughly EUR 75 billion in the capital market.

4.  How does KfW balance investment risk against generating a commercial rate of return?

KfW's business model allows for KfW's priority being aligned with existing policy goals. The commercial decision on which project may be supported is taken by the commercial banks, ie the market. Adverse selection is being avoided by making sure that the commercial bank always assumes part of the risk.

Additionally, KfW has a risk management in place according to banking industry standards.

5.  How is KfW's performance measured and reported?

KfW's performance is mainly measured in loan commitments per year and the impact achieved by the different programs offered (ie effects intended by the promotional program like creation of jobs, CO2 emissions avoided, volume of investments generated etc). Since promotional goals differ between the promotional programs, it is difficult to compare the products amongst each other.

6.  What lessons should the UK learn from KfW?

For the last 60 years KfW's business model has proven to be an efficient and lean promotional model as it allows for:

  • a large number of projects and;
  • a range of promotional goals;
  • to be supported simultaneously; and
  • at low cost for the public sector.

This business model is subsidiary to the market since it always involves the commercial banks and leaves an opportunity for the commercial bank to match KfW's terms or undercut them. By using the commercial banks as a distribution channel, the business model minimizes potential crowding out effects of promotional loans.

The key to efficient support of the economy is the funding capacity of a AAA rated state backed institution in combination with highly standardized loan programs which are then structured into tailor made financing packages by the commercial banks, ie the market.

When setting up a promotional bank in the UK, the decision on the "promotional model" should be made eg against policy goals or the financing culture in the UK.

25 November 2010

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