Source: Local Economies (UK)
Author: Helena Vieira
Date published: 2025-09-11
[original article can be accessed via hyperlink at the end]
Community banks are emerging as critical enablers of the net-zero transition, offering relationship-based lending and local market insight that larger institutions often lack. Nse Udohaya writes that unlocking the potential of these grassroots lenders will be essential to delivering inclusive and effective decarbonisation.
The global pursuit of net-zero greenhouse gas emissions by 2050 demands a profound economic transformation. Financial institutions have a key role to play in directing capital towards decarbonisation and mitigating climate-related risks. However, a lot of attention is paid to large-scale institutional investors. Local and community banks are overlooked, even though they have untapped potential in the granular implementation of net-zero strategies.
Leveraging the distinct capabilities of community finance is not merely supplementary. These smaller institutions are essential for a comprehensive, equitable and effective transition to a sustainable future.
Distinctive operational model
Community banks, characterised by their local embeddedness and community-centric ethos, particularly prevalent in countries like the United States and across the Global South, offer a unique operational model. Unlike larger financial institutions, which typically centralise loan decisions and provide a broad array of services, community banks operate on a distinctly relationship-driven basis. Creditworthiness is assessed not solely through quantitative measures but also on qualitative factors such as a borrower’s history with the bank, personal characteristics and local potential. This approach, rooted in empowerment-based economics, prioritises fostering socio-economic growth within communities.
This relationship-driven underwriting grants community banks a fundamental advantage in green finance. Their inherent understanding of local needs and market conditions enables a more nuanced evaluation of the perceived risks associated with nascent green projects or local businesses engaged in decarbonisation efforts, which larger institutions might deem too complex due to a lack of granular data.
This “proximity premium” in risk assessment translates directly into a higher likelihood of funding for grassroots decarbonisation initiatives, such as home energy efficiency upgrades, solar panel installations or the purchase of electric vehicles, all of which makes community banks uniquely positioned to support the transition. They are more likely to offer tailored and flexible financing solutions, crucial for small and medium-sized enterprises (SMEs) and individual households, which are key drivers of real-economy decarbonisation but often face difficulties accessing finance from larger banks.
Green grassroots initiatives
Community banks are effective in funding renewable energy projects and green infrastructure, especially in underserved rural areas. Examples include green banks in the US, like the Connecticut Green Bank and the NY Green Bank, and community-funded projects in the UK, such as the Gamlingay Community Wind Turbine.
UK banks and building societies offer green mortgages and loans to incentivise home energy improvements. These institutions serve as a vital pathway for SMEs to adopt sustainable practices through green and sustainability-linked loans. By financing smaller, localised and often more experimental projects, community banks foster an environment where context-specific, effective pathways to net-zero can be discovered and refined, providing valuable models for broader adoption.
Community green lending
Despite their significant potential, community banks face structural challenges in scaling their green lending efforts. Regulatory compliance burdens are disproportionately costly for smaller institutions, hindering their ability to manage new reporting requirements and recruit specialist staff. Capital requirements can constrain lending, and current frameworks often fail to adequately incentivise green financing.
For specialised green banks, the primary issue is usually not a lack of capital, but the challenge of efficiently deploying it to numerous smaller projects, which demand extensive due diligence and data management, creating operational bottlenecks.
Additionally, community banks operate in a competitive landscape, facing pressure from larger banks and new market entrants, exacerbated by an uneven playing field due to differing tax and regulatory treatments. A significant barrier for SMEs is a pervasive lack of awareness regarding available green finance options. Finally, the evolving nature of climate change finance presents challenges in data quality, analytical tools and climate-related capabilities across the financial industry.
Policy recommendations
To fully realise the potential of community finance for net-zero, policymakers must adopt tailored regulations that move beyond a one-size-fits-all approach, providing proportional oversight that eases compliance burdens for smaller institutions. Establishing and supporting green banks or similar public-purpose financial institutions is essential, as these entities are designed to overcome barriers to private capital mobilisation for climate-aligned investments by mitigating perceived risks and offering credit support to local lenders.
Beyond regulatory adjustments, direct incentives for green lending are vital, such as implementing green capital requirements. Central banks could repurpose existing monetary policy schemes to offer zero or negative real interest rates for green activities, thereby significantly lowering borrowing costs for critical investments and extending credit to alternative banking sectors.
Fostering a comprehensive and supportive ecosystem requires active collaboration between Development Finance Institutions (DFIs) and financial regulators, promoting knowledge sharing and providing targeted technical assistance. Critically, policy should prioritise funding and facilitate knowledge transfer and technological upgrades for community banks, empowering them to become fully effective agents of the green transition. This addresses their current lack of sophisticated climate-related capabilities and advanced digital infrastructure
Conclusion
The net-zero transition requires contributions from all financial sectors, with local banking and community finance playing a crucial role in grassroots decarbonisation. Their unique, relationship-driven models and deep local embeddedness enable the financing of critical green initiatives and demonstrate tangible environmental and socio-economic impacts.
Unlocking the full potential of these local institutions requires tailored regulation, strengthened green banks, and public-private partnerships, as well as targeted green credit policies and strategic investment to address regulatory burdens and capacity gaps, thereby fostering a more inclusive, resilient and locally driven net-zero future.
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