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Driving change: Embracing ESG banking in Indonesia
Banks can gradually enhance their risk management frameworks to better reflect the impacts of climate change on their operations.
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Environmental activists hold placards in front of public toilets full of plastic waste on April 17, 2023, during a climate change campaign to mark Earth Day in Surabaya, East Java. (AFP/Juni Kriswanto)
T
he climate crisis is driving an increase in voluntary commitments by financial institutions to reduce emissions. National and international ESG (environmental, social and governance) policies are evolving and transitioning from voluntary to mandatory relatively quickly.
Indonesia has made ESG disclosure mandatory through the Financial Services Authority (OJK) Regulation No. 51/2017 on sustainable finance. But disclosure is only the first step, and it does not do enough to push banks and portfolio managers to internalize ESG principles when assessing projects that land on their desks.
Indonesia’s banks are not yet ready to fully account for ESG in their internal procedures and management systems. As a result, we have seen voluntary commitments to ESG policies being used as a framework to shift investment portfolios into greener projects, and we have also seen others sticking to high carbon-emitting projects with strong yields. Strategically planned steps are therefore crucial to help banks and financial institutions strengthen their contributions to climate finance while also successfully undergoing sustainable business transformations to meet the upcoming financial industry standards.
A crucial step toward embracing ESG investing is accounting for the climate risks associated with all investment portfolios and financing activities. These risks include physical risks, such as floods and heatwaves, and transition risks resulting from new technologies and a policy shift toward a more sustainable economy. While a comprehensive, quantitative assessment of climate risks may be complex, an initial qualitative understanding of how climate-related risks may affect financed assets can be a useful starting point.
Banks can gradually enhance their risk management frameworks to better reflect the impacts of climate risks on their operations and comply with disclosure standards. At the national level, banks should start aligning their portfolios with the Indonesia Green Taxonomy 1.0, launched in January 2022, as a key guideline.
And while fully adopting international standards may entail greater commitment, integrating more climate-focused disclosure benchmarks into existing risk management frameworks is strategically important in helping stakeholders understand, measure and manage climate risks.
A notable related development is the Basel Climate Principles (introduced in June 2022), which require internationally active banks to assess financially material climate risks throughout the credit lifecycle, from client onboarding to the ongoing monitoring of clients’ climate-related credit risk profiles.
