The people of Munich are an ambitious bunch. The Bavarian capital aims to be climate-neutral by 2035, faster than Germany as a whole, which is not aiming for this status until 2045. To achieve this, the city expects to spend an additional 100 million euros - per year. An immense sum, even for the wealthy Isar metropolis. Green bonds are therefore intended to flush the money into the city's coffers. These differ from traditional bonds in that they are usually earmarked for a specific purpose and the money raised may only be used for sustainable purposes.

Such Green City Bonds are still relatively rare in Germany, but quite popular abroad. Many cities are happy to use them. Gothenburg, for example, raised 2.5 billion euros in five years to electrify the city's own bus fleet and build a railroad tunnel. Johannesburg has also bought new buses with a Green City Bond.

If this trend now also arrives in Germany, it could mean a fundamental shift in municipal financing. This is because cities and municipalities have rarely relied on borrowed capital to finance their investments. Last year, the municipal panel of the state development bank KfW came to the conclusion that own funds and subsidies cover around 80 percent of expenditure. And the fifth of borrowed capital has so far not come from bonds or other forays into the debt capital market, but from bank loans.

However, local authorities are currently facing an extremely difficult environment. "The years before coronavirus were good, the municipalities had high surpluses," explains René Geißler. He has been Professor of Public Economics and Administration at Wildau University of Applied Sciences since 2020, having previously spent years working on municipal finances at the Bertelsmann Foundation. "But there is a great deal of uncertainty for 2021 and the coming years," he continues: "And in practice, uncertainty means reducing expenditure as much as possible and avoiding new projects." Traditionally, municipalities would be the first to cut back on investments when money is tight. But that's a bad thing, because municipalities also have to help finance the transformation of the economy towards sustainability. And they also have to cushion the impact of the pandemic. In addition, there is an investment backlog in the three-digit billion range that already existed before coronavirus.

KfW therefore predicts that borrowing by local authorities will increase in the coming years. Cities had already issued more bonds after the financial crisis, for example. In 2009, for example, the town of Quickborn turned to its own citizens to collect money. Quickborn residents could expect annual interest of three percent from a minimum investment amount of 5,000 euros. This was a good deal for the town, as this interest rate was below the usual rate for municipal loans at the time. Four million euros were raised in this way.

However, it quickly became apparent that such a project was not quite as easy to handle as the citizens and local authorities in the small town in Schleswig-Holstein had imagined. The financial supervisory authority BaFin identified the structure as a deposit business, which in Germany can only be operated with a banking license. Quickborn did find a way to save the citizens' bond by working with a bank. In the end, the town financed the renovation of a school and a fire station. But the example shows the effort involved in such a bond.

"And this effort is only worthwhile, if at all, above a certain amount," says Geißler. Accordingly, a bond is only of interest to large cities such as Munich, or for mergers of several small municipalities. The expert does not believe that bonds will become a widespread instrument in Germany, even if they are explicitly linked to climate protection, as is the case with Green City Bonds. "It's often mainly about marketing," he says. In total, there are just eight current bonds in Germany.

Compared to the period after the financial crisis, one factor has also changed: The interest rate level. As a result, traditional bank loans are more attractive than ever for local authorities. Landesbanken, development banks and savings banks in particular are happy to issue municipal loans, partly because municipalities are welcome business partners. In fact, municipalities in Germany cannot go bankrupt, as the federal states are liable in the event of an emergency.

Stephan Brand and Johannes Steinbrecher, both experts in municipal finance at KfW Research, also point out in an article for the magazine Wirtschaftsdienst that many municipalities had significantly reduced their debt burden before coronavirus. "Municipal loans can therefore continue to play an important role in securing investments in the coming years," they conclude.

However, experts also believe that municipal loans alone will probably not be enough to finance all investments, especially when it comes to restructuring the economy. Tax increases could become an issue, especially for property tax, which is an important source of income for municipalities. "But the federal and state governments will also have to step in with funding programs," says René Geißler from TH Wildau. He also calls for the supervisory authorities to give local authorities more leeway. "Because that's often the bottleneck at the moment," he says. Supervisory authorities often cap municipal loans at a point that is not economically feasible. "Then the municipalities are no longer allowed to take out loans, even though they can easily afford them."

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