India’s ambition to become a developed, low-carbon economy, often called ‘green transition’, will require not only sustained economic growth but also an unprecedented mobilisation of capital. NITI Aayog estimates that achieving net zero, a comprehensive green transition, will require a cumulative investment of US$22.7 trillion by 2070, leaving a financing gap of US$6.5 trillion. While estimates vary, they all point to one conclusion: India needs a humongous volume of capital to finance its green transition.

Banks and NBFCs have limitations

One of the key reasons for the capital shortfall is the heavy reliance on banks and NBFCs for debt capital, and corporate internal capital and foreign investors for equity capital. Though they are central to providing capital for the green transition, they cannot finance it on their own.

Banks’ primary source of capital is short- to medium-term deposits, while green assets—renewable energy, transmission networks, battery storage, and clean mobility—require capital that can remain invested for a longer period—5 to 30 years. Financing long-duration assets with short- to medium-term deposits creates asset-liability mismatches for banks, and the Reserve Bank of India (RBI) discourages banks from increasing their exposure to long-term finance. On the other hand, green companies that borrow short- to medium-term debt, mostly in the 5–7-year range, from banks face refinancing risks, as they need debt capital for a longer period. Non-Banking Financial Companies (NBFCs) are another source of capital, but most infrastructure NBFCs suitable for the renewable energy sector are Public Sector Units, and excessive debt from these NBFCs could create contingent liability risks for the Government.

This makes it imperative to look beyond conventional lenders and tap India’s growing pool of long-term institutional investors.

Institutional investors are untapped for green finance

Green companies have not been able to access a large and rapidly growing pool of long-term capital from domestic institutions, such as pension funds, insurance companies, and mutual funds. Together, they manage around ₹180 trillion (US$2.1 trillion) in assets, which is expected to grow significantly over the coming decades as household savings increasingly move towards market-linked financial products. These institutions will play a crucial role in financing the transition. According to a recent report by Climate and Sustainability Initiative (CSI), these domestic institutional investors can mobilise up to US$1.2 trillion for green investments between 2026 and 2050, equivalent to roughly 15 per cent of India’s financing requirement. With the right regulatory reforms, market incentives and financing structures, this contribution could be significantly higher.

These institutional investors are natural financiers of green assets. Operational renewable energy projects, regulated transmission assets, and other mature infrastructure generate stable, predictable cash flows that align with these investors’ low-risk, long-term objectives. These investors seek low-to-moderate risk-adjusted returns through transparent, well-governed, scalable assets that meet regulatory, size, and liquidity requirements. Despite this significant potential, institutional investment in green infrastructure remains limited

Challenge to investment in green assets

One reason institutional investment remains limited is its ultra-conservative investment framework, designed to protect pensioners and insurance policyholders from downside risk. For example, pension funds and insurance companies are permitted to invest only in highly rated securities, typically rated AA or higher. As a result, newer green projects and companies with lower initial ratings often remain outside their investment universe despite having strong long-term fundamentals. Moreover, these institutions have limited capacity to invest directly in projects or in unlisted companies, which prevents them from investing in green assets that are not listed on the stock or bond markets.

Ultra conservative investment approach and limited capacity are major barriers

Alternative assets like Infrastructure Investment Trusts (InvITs), Alternative Investment Funds (AIFs), and securitised loans enable investors to allocate capital to unlisted companies, including green companies. However, these investment vehicles currently account for only a small share of these institutional investors’ portfolios, even though regulations permit greater allocations. For example, while pension funds can allocate up to 5 per cent of their corpus to alternative assets, their actual allocation is only 0.2 per cent. A lack of human resource capacity and experience in alternative investment assets limits pension and insurance companies’ participation in green companies, even leading to lower returns on their investment. These safeguards, while well-intentioned, have also become institutional bottlenecks.

Unlocking institutional capital requires both market innovation and regulatory reform

Three reforms can significantly improve institutional participation in India’s green transition.

First, strengthening credit enhancement mechanisms. Instruments such as partial credit guarantees and loan loss reserves can improve the credit profiles of green projects and help green bonds achieve investment-grade ratings, thereby attracting these investors. A dedicated National Green Guarantee Corporation could play a catalytic role by reducing perceived risks and attracting larger pools of private capital.Second, India should deepen capital market instruments that recycle capital efficiently. Green asset securitisation, AIFs, and Green InvITs allow developers to monetise operational renewable energy projects and other mature infrastructure assets. Banks can sell seasoned loans to institutional investors through these alternative investment vehicles, which enable the former free up capital for new investments.

Finally, preferential regulations and policy incentives can accelerate capital mobilisation. Preferential tax treatment of green bond interest income or returns on green AIFs would improve post-tax returns for investors. Similarly, insurance and pension regulators can require their regulated fund management companies to allocate a minimum of 2 per cent of the corpus to green assets. Once these investors are mainstreamed in the green sector, these incentives can be withdrawn.

As green assets are strategic in nature, like infrastructure assets, this regulatory and policy incentive for a short period is legitimate.

A strategic opportunity: Investments in green assets can mitigate climate risk

Globally, financial regulators are closely monitoring climate-related financial risks and increasingly encouraging financial institutions to integrate them into their investment decision-making. An incremental capital allocation to green assets can also mitigate climate-related financial risks, which are expected to materialise in the long term.

Long-term institutional investors have the potential to bridge a significant share of India’s green financing gap. Unlocking this capital, however, will require stronger credit enhancement mechanisms, deeper capital markets, targeted regulatory support and greater institutional capacity. If these reforms are undertaken, institutional investors can become a key source of finance for India’s green transition.

By Labanya Prakash Jena and Shubhansh Garg are, respectively, Director and Senior Analyst at Climate and Sustainability Initiative (CSI). Views expressed are personal.

Originally published in Illuminem