The city of Banja Luka has secured loans worth €8.4 million (£7.5bn) from the European Bank for Reconstruction and Development (EBRD) for the project.
It will be used to develop the new plant and establish a new district heating company in a joint venture with a private firm.
The switch from oil to green heating is expected to slash emissions by more than 90% and save up to €900,000 (£803,025) in 2018 alone.
Jan Dusik, Head of UN Environment’s Europe Office, which supported the project, said: “I am proud to see Banja Luka become the first pilot city in the world to attract private investment and a loan from an international institution under the District Energy in Cities Initiative.
“This is a real example of change that can be achieved in favour of citizens and the economy while fighting pollution.”