Adopting Sustainable Finance Regulation for Islamic Financial
Institutions in Indonesia
Hayu Susilo Prabowo
Indonesia Banking School, Jl. Kemang Raya no. 35, Jakarta, Indonesia
Keywords: Sustainable Financing, Islamic Economics, ESG.
Abstract: The interaction between people and environment are very vital because functioning ecosystem services are
important resources for the people. The economy is a subsystem of human society, which is also a
subsystem of the life on earth and its ecosystem. The issue of environmental change has shifted from a
peripheral concern of scientists and environmentalists to being a central issue in the global policy-making.
To ensure global long-term financial stability and economic development, financial institutions need to
significantly change their performance to promote more responsible and sustainable business practices. The
Financial Services Authority of Indonesia has unveiled a roadmap, which sets forth the end goal of
sustainable finance in Indonesia by the financial services industry and determines the benchmark for
improvements in sustainable finance. This paper explains the complementarities of Islamic worldview and
sustainable financing policies. Under the term Environment, Social and Governance, the ethical theory of
Islamic economics focuses only on the social and governance, the environment under sustainable finance
have not been fully considered. Therefore, the adoption of sustainable financing concept in Islamic financial
services institutions will enrich Islamic economics to attain Islam rahmatan lil ‘alamin (Islam is a blessing
and mercy to the entire universe).
1 INTRODUCTION
The world has experienced tremendous economic
progress. The side effects of the development
process have also been enormous – loss of
biodiversity, climate change, environmental damage,
etc., which brought about social issues such as
poverty alleviation. On the other hand, the economy
is an important tool in developing social policies and
the protection and management of the environment
and natural resources. Economy is also a tool to
provide information about options, costs, and
benefits of various actions to be decided along with
the measurement results (Cato, 2009).
However, at the heart of the efforts of
environmental protection is the need to resolve an
essential intellectual problem. The problem is that
the body of economics, scientific, and social
knowledge that we have developed over the
centuries has been based on a clear differentiation
between humans and nature - between natural and
social conditions (Schumacher, undated). This
differentiation has allowed us to parcel social
problems in small pieces and to place these under
analytical and empirical scrutiny (Choucri, 1995).
This is but one of many indications that our
economy is in fundamental conflict with our
ecological systems. For this reason, we need a new
paradigm of economy, which is more concerned
with the quality of human life. Choudhury (1993a)
introduces the idea that sustainable socioeconomic
development comprehends relationships between
economy and society in the perspective of an
integrated study of policy and the market system.
Development is the theory, process, and realization
of certain major social and economic objectives
simultaneously. In this light, no separate preference
is placed on one over the other: the social
(distributive equity) and economic goals (economic
efficiency) both need to be attained (the equity-
efficiency principle).
The United Nations (United Nations, 2014) in
cooperation with various governments, civil society
and other economic players have developed a
sustainable development framework that is expected
to bring both economic and environmental
sustainability interests together, provide economic
transformation, and expand access to alleviate
Prabowo, H.
Adopting Sustainable Finance Regulation for Islamic Financial Institutions in Indonesia.
In Proceedings of the 1st International Conference on Islamic Economics, Business, and Philanthropy (ICIEBP 2017) - Transforming Islamic Economy and Societies, pages 157-162
ISBN: 978-989-758-315-5
Copyright © 2018 by SCITEPRESS – Science and Technology Publications, Lda. All rights reserved
157

poverty from the poor and enforce justice. This also
takes into account that the social and environmental
issues, which have not been included in the
economic calculations, have become important
elements that need to be considered. The balance
between the importance to make profits does not
legitimize a lower attention and commitment to
protecting the environment and a better social life.
The two most common aspects of sustainable
finance (i) the sustainability factor, and (ii) the
interrelationship between ESG issues and financial
issues. Thus, sustainable finance looks at how
investing, lending, and financing interacts with
environmental, social, and governance issues over a
given period. Sustainable finance is not merely
focused on how to make a profit while investing
with a "green" conscience, but how green
investments lead to profit and benefits for
environmental, social, and governance issues
(Krauss et al., 2016).
The systemic nature of environmental issues and
the globalization of the economy that gives rise to
them are making international interdependence an
inescapable reality. Climate change remains the top
concern of global leaders per last year’s World
Economic Forum survey. As the fourth largest
nation in the world, Indonesia will play its part in
meeting this global challenge (Indrawati, 2017).
Indonesia’s social issues, such as environmental
damage and poverty alleviation, become more
important as the country has progressed
economically because the people who are most
affected by the changes to the natural environment
are those who live in the poorest areas and who have
usually contributed the least to the environmental
problems. Their problems arise because they often
rely on agriculture and natural resources that are
threatened by the rising temperatures and extreme
climate change. They are also amongst those most
vulnerable to natural disasters and lack the
mechanisms to cope with their effects.
The objective of this paper is to explain the
complementarities of Islamic worldview and
sustainable financing policies. the ethical theory of
Islamic economics focuses only on the social and
governance, the environment under sustainable
finance has not been fully considered, especially on
the term of Environment, Social and Governance.
2 INDONESIA STRATEGY ON
SUSTAINABLE FINANCING
Hadad and Maftuchah (2015) revealed that the
Indonesian Ministry of National Development
Planning creates Indonesia development plan which
utilized two financing sources, approximately 20%
from government and 80% from private sectors.
Government funding sources include taxes and non-
taxes, domestic and foreign grants, domestic &
overseas loans, while the private sectors (non-state
budget) are financed through bank and non-banks,
business entities (domestic/international), and
various sources. The combination of development
funding is a collaboration between the government
and the private sector / public-private partnership in
the form of social responsibility through corporate
social responsibility (CSR) as well as religious
social funds. Given that 80% of the development
financing is supported by the private sector, the role
of the financial services industry is substantial to
support Indonesia's economic growth. Therefore,
financial institutions need to understand that
negative ESG outcomes caused by their financing,
client relationships and advisory decisions can affect
them and may cause reputational and brand damage
(WWF, 2014).
The Financial Services Authority of Indonesia
(OJK), unveiled a roadmap which sets forth the
benchmark and the end goal of sustainable finance
in Indonesia for the financial services industry under
the supervision of OJK (Indonesia Financial
Services Authority, 2014). Implementation of
strategic activities of sustainable finance in
Indonesia is comprised of three main areas:
1. Increase the supply of environmentally friendly
financing.
2. Increase demand for environmentally friendly
financing products.
3. Increase oversight and coordination of
sustainable finance implementation.
Setijawan (2017) described that sustainable
finance was not just about financing renewable
energy companies; it was also about working with
clients and portfolio companies to help advancing
them along the sustainability through proper ESG
risk management policies, processes and protocols in
place. In the long term, the distribution of
sustainable financing to strategic sector industries is
expected to encourage sustainable economic growth,
which in turn will provide a larger market for
Financial Services Institutions (FSI). The creation of
a larger market along with its generated economic
growth will have a positive impact on the
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sustainability of FSI in particular and is also
expected to reduce Indonesia’s balance of payments
deficit. To support the implementation of
Sustainable Finance stipulated in Indonesian law
Number 32/2009 regarding Environmental
Protection and Management, in July 2017 OJK
issued a regulation on Sustainable Finance, namely
POJK Number 51/POJK.03/2017 regarding the
Application of Sustainable Finance for FSI, Issuer,
and Public Companies. Figure 1 presents the role
and position of OJK regulation in the overall
sustainable financing strategy. In broad-spectrum,
the Sustainable Financing Strategy in Indonesia can
be broken up into Supply Side and Demand Side for
financing. OJK is accountable to regulate the
development of the supply side, while the
government is accountable for the development of
the demand side.
At the supply side, it is necessary to shape a
contributive financial services system to achieve
financial system stability by strengthening ESG.
This means that sustainable financial programs not
only seek to grow the financing but also to improve
the resilience and competitiveness of FSI. The
development for resiliency and competitiveness is
based on the rationale that sustainable finance is a
new challenge coupled with a new opportunity
where the FSI is able to grow and reach financial
stability by integrating ESG. On the other hand,
Financial Services System (FSS) should be more
prudent in its investment decision to sustain its
financial integrity through more selective
investments, whether in the form of credit, debt, or
other options by incorporating ESG as the
instrument to filter the investment. Financial
integrity can be interpreted that in the management
of credit/finance of the financial services industry, it
is necessary to examine the various risks to avoid the
materialization of problems that are not desirable
during the process and after credit/financing take
place.
Nonetheless, if the focus of financing is only on
the integrity aspect, it will result in an economic
contraction as FSS will only focus its attention to
environmental issues which will result in many
financing projects being rejected. Therefore, it has to
be balanced with financing expansion that FSS
should be both contributive and inclusive in the
provision of sustainable development financing.
Financial inclusion means that the financing is able
Figure 1: Sustainable Financing Strategy (by Setijawan, 2017).
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to protect and manage the problems that may arise
due to the environmental and social issues.
FSS has to be more selective, but at the same
time; has to drive the cooperation among related
sectors to achieve government commitment in
Sustainable Development Goals, one of which is
related to environmental aspect. For example, by
stimulating the investment in renewable energy,
energy efficiency, green building, eco-tourism,
recycling industry, etc. So, this policy is not
contractive but also expansive financing and is
expected to expand Indonesian economy through
financing sustainable business sectors. The
implementation of this strategy mix will be achieved
through:
1. Establishment of Environmental, Social and
Governance (ESG) in the financing decision.
Provide understanding and strengthening FSS on
ESG risks and rewards.
2. Development of sustainable financial services
products and capital markets.
Encourage green innovation or sustainable
finance products. For example, in the capital
market, initially, the market uses the term green
bond. However, before it was implemented in
Indonesia, the sustainable bond or social bond
emerges in the market. There will be 3 types of
bonds, i.e. (i) green bond emphasizes the aspect
of environmental, (ii) Social bond focus on
social, (iii) Sustainable bond focus on both
environmental and social aspects.
3. Strengthening Financial markets through the
development of domestic carbon markets and
other sustainable financial market instruments.
This section is broken down into two with the
dotted line in the middle. This shows that the
development of this section requires the
involvement of non-OJK parties, namely the
government. The government determines who is
green and what is green, as OJK has no
competencies to do so. The development of
carbon market mechanism should involve cross-
sectoral ministries and agencies, including the
ministry of finance, the ministry of environment
and forestry, etc.
Once the Supply side formed the sources of
financing, it has to be balanced with the formation of
demand for sustainable financing, as the demand
side. The demand for this type of financing will
inevitably be many, but the demand must meet the
financial services system requirements.
The development of the demand side is not the
scope of OJK authority, so good coordination with
government is critical to the success of the program.
For this reason, OJK has intensively discussed the
plan with the Ministry of Energy and Natural
Resources and other ministries, especially for the
development of New and Renewable Energy. This
financing will be related to the incentives and
disincentives by the government for green industry
or sustainable industry. OJK two long-term
development targets through this policy are:
1. Sustainable products market development for
domestic & ASEAN.
2. Development of supporting sustainable products
industrial centers.
The development of the domestic market for
sustainable products will grow demand for these
products, such as hydroelectric power plants that
require turbines and solar cells. In addition, there are
also increasing interest in green lifestyle, where
people tend to choose green products, such as
organic rice or the use of environmentally friendly
products. This will also foster demand.
However, the development of the domestic
market needs to be coupled with the development of
the industry supporting sustainable products, as most
of the technology, machines or solar cells, are still
imported. Fail to do so, Indonesia will only be a
consumer and will not get any benefit from this
policy. Therefore, it is important to work in
cooperation with Indonesian Agency for Technology
Assessment and Application (BPPT), Ministry of
Industries, and Ministry of Trades, so that domestic
sustainable industries can be developed domestically
to meet the increase in demand.
In order for the domestic products to be
competitive with imported products, the design of
the strategy embraces ASEAN countries. Through
this strategy, the potential consumers will increase to
600 million from 250 million if the coverage is only
in Indonesia. This large number of potential
consumers is expected to assist the industry to reach
the economies of scale so that the products can
compete head-to-head with non-ASEAN products.
Again, this demand-side development is not OJK
capacity; therefore, OJK requires the support of
government regulation and agreement from ASEAN
countries.
With the enactment of the POJK regulation on
Sustainable Financing, several basic Sustainable
Finance Guidelines will be developed and available
by 2019 (International Finance Corporation, 2017).
The guidelines include: Green bond guidelines,
Green Insurance guidelines, carbon market
guidelines, etc. These guidelines will cover:
• ESG Guidelines for FSI and FSI auditors.
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• Reporting System. Standard reporting enables OJK
to categorize whether a financing is classified as
sustainable or not as it relates to incentive and
disincentives scheme.
• Pilot Project: First and Second Movers for
Sustainable Finance Institution.
In order to implement this sustainable fiscal
policy, FSI participation is required in the form of a
pilot project. Since 2016, OJK has received
commitments from 8 banks of this program, namely
BRI, BNI, Mandiri, BCA, Artha Graha, Bank Jabar
Banten, BRI Syariah, and Muamalat with total assets
of 46% of total banking portfolio in Indonesia
(Yudawinata, 2016). If this pilot project goes well, it
has already covered half of the banking industry.
Lastly, in order to measure the effectiveness of
the implementation of this policy in the future, a
Baseline Survey has been initiated in 2017.
3 ISLAMIC ECONOMICS
THOUGHTS OF ESG
Humans are the guardians of the earth and are
entrusted to protect it for the future generations.
Despite that, currently millions of people are
suffering as a result of the damage to the
environment. The people who are most affected by
the changes to the natural environment are those
who live in the world’s poorest countries and who
have usually contributed the least to the world’s
environmental problems.
In the development of Islamic economics, the
scholars refer to the verses of the Qur'an and the
relevant Hadith to establish the basic principles
governing the rights and obligations of economic
actors following the framework maslahah mursalah.
Maslahah mursalah is maslahah that there is no
sharia (Islamic divine law) provision to make it
happen and there is no sharia argument to consider it
or ignore it.
Maslahah consists of "considerations that secure
the benefits or prevent damage but, in accordance
with the purpose (maqashid) of Sharia. Any action
that keeps these values are included in the scope of
maslahah and anything that violates is mafsadah
(crime), and the act of preventing crime as well is
maslahah". The purpose of sharia consists of five
values of protection, namely: religion, life, mind,
descent and wealth, which has a very wide spectrum
and meaning (Dusuki and Abdullah, undated).
The basis of Islamic economics obliged that
every transaction needs to obey Islamic contract
(Aqd), prohibition of riba (usury and unearned
income), maisir (gambling), gharar (uncertainty)
and maksiat (breaking of a religious law). These are
the center of Islamic economic in defining whether a
transaction is lawful or not (Khan, 2002).
Islam commands to eat from whatever is on earth
that is lawful (halal) and good (thayyib) (Qur'an, 2:
168). The Islamic scholars divine that thayyib is
what makes good physical, spiritual, intellect and
morality of man (akhlaq). Consuming halalan
thayiban is one manifestation of faith because it
means following the command of God. However,
the current Islamic economics only emphasize its
attention on to the transactions that are lawful
(halal) and unlawful (haram) aspect, no elaboration
on the aspect of thayyib (good transaction),
especially the acknowledgment on ESG.
ESG issues are significantly relevant in Islamic
teaching, which commands relationship with God,
the relationship among man and the relationship
with nature (hablum minallah, hablum minannas
and hablum minal alam) (Al-Qaradhawi, 2001).
Therefore, sustainable financing policy should be an
integral part of the Islamic economics. Sustainable
financing is a reflection that Islam as a religion of
rahmatan lil 'alamin means Islam is a religion that
brings grace and prosperity to the entire universe,
including animals, plants and jinns, let alone fellow
human beings (Qur'an, 21: 107).
4 CONCLUSIONS
Indonesia Financial Services Authority has regulated
sustainable development for the financial services
industry embodied in the sustainable finance
roadmap and Indonesia law Number 32/2009. The
sustainable strategy was established based upon the
interrelationship between demand and supply
elements for sustainable finance products such that
complimentary actions from both financial services
industry at supply side and industries at demand side
will achieve optimal and sustainable growth.
Nevertheless, the supervision of sustainable
financial implementation remains a priority, in line
with efforts to create financial system stability.
The term sustainable financing conveys the fact
that society and economics, finance, polity,
institutions etc. cannot be independent of a unique
and common set of moral and ethical values. The
ESG concept is completely in line with the
Maslahah concept under shariah law. It embeds
moral and ethical values encompassing economic,
environmental and social in the body of economics
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aligned with the shariah ruling. However, the theory
and practice of Islamic economics and finance have
not brought sound environment and social justice to
improve human well-being, balancing the social
justice and economic goals. Hence, Islamic
economic institutions should adopt the OJK
regulation as it corresponds with the concept of
maslahah.
REFERENCES
Al-Qaradhawi, Y. 2001. Islam Agama Ramah Lingkungan,
Jakarta, Pustaka Al-Kautsar.
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ABBREVIATIONS
ASEAN
The Association of Southeast Asian
Nations
ESG
Environment, Social and Governance
FSI
Financial Services Institutions
FSS
Financial Services System
OJK
The Financial Services Authority of
Indonesia (Otoritas Jasa Keuangan)
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