A commercial loan is a debt-based financing mechanism between the municipality and a financial institution such as a bank used to fund capital expenditures and operating costs. The loan is made available at market rate. Many commercial loans require a good credit rating and/or collateral in the form of municipal assets. Municipalities with a larger revenue base are more attractive to commercial banks (ESMAP 2014). Public funds available at national, state or regional governmental levels vary from country to country and can range from limited budgets to non-existent capital. Therefore, municipalities with a larger revenue base are more attractive to commercial banks (ESMAP 2014).
A loan makes the necessary capital available to invest in a particular activity that, ideally, increases the overall value of the borrowing entity, going off the assumption that this increase in value can be used to pay off the loan and associated interest to the creditor. Thereby, other, own capital sources, remain available to invest elsewhere, allowing for an overall increasement in value creation. Further, taking out a debt in form of a loan allows the borrower to receive financing without losing ownership, as would be the case with receiving capital via issuing equity. Being the traditional form of funding, the municipality is acquainted with the associated risks. This funding type can be combined with other forms of funding, thus, diversifying the portfolio and spreading the risks associated with different instruments.
This funding type might need collateral security in the form of assets if the creditworthiness does not meet the satisfaction of the bank. Further, the borrower would need to consider the price of this form of financing in the form of Interest rates. These may be higher than with other, supported, financing instruments.
ESMAP. 2014. "Financing Municipal Energy Efficiency Projects."