New lending rule helps protect our environment

New lending rule helps protect our environment

Jan Willem van Gelder and Fitrian Ardiansyah, Amsterdam/Jakarta

Let us hail the new regulation issued by the central bank (Bank
Indonesia or BI), which demands that banks assess their corporate
clients, does not do enough to protect the environment (BI
Regulation No. 7/2/PBI/2005, concerning Asset Quality Rating for
Commercial Banks).

This can be seen as a promising first step to stimulate the
financial sector to help save the environment as banks play
important roles in financing the forestry, plantation, mining and
other important sectors related to environmental issues.

Few countries around the world have such an abundance of
natural resources at their disposal as Indonesia has. Various
forest products, oil and gas, minerals and agricultural
commodities: all these are produced in large quantities in
Indonesia.

By exporting these commodities, Indonesia is earning valuable
foreign currency -- 56 percent of the export value was made up by
the export of such commodities in 2003. These export earnings can
theoretically be used to finance numerous development projects.

But reality speaks differently in Indonesia. While the
abundance of commodities could be a blessing to all, for many
Indonesians as well as for its natural environment it is nothing
less than a curse. The United Nations Food and Agriculture
Organization (FAO) said Indonesia was among the countries that
suffered the greatest losses of natural forests.

Precious ecosystems get destabilized and their functions and
services ultimately disappear, causing the demise of many
wildlife species and valuable biodiversity as well as the loss of
rights and means of living for indigenous and local communities
dependent on extensive interaction forms of agriculture and
forestry.

The question now becomes, why is this abundance of commodities
not bringing wealth to the country as a whole, and improving life
for all the poor people?

There are many factors contributing to this. The insatiable
international demand for Indonesian commodities stimulates a
continuous increase in production capacity and exploitation of
natural resources. Unfortunately, because of corruption and a
weakly enforced judicial system, irresponsible corporate behavior
is not controlled.

Many actors (e.g. producers, buyers, financiers, government
officials) are involved in these processes and each carries its
own responsibility and could contribute to a more responsible
management of commodities.

We must not forget the other actors -- banks and other
financial institutions (FIs) -- that play an indispensable role
in supplying capital to commodity producing companies by
providing loans or buying their shares.

In the past decade, for instance, more than US$10 billion was
invested in the oil palm plantation sector by both national and
foreign investors. In pulp and paper industries, the growth over
the past decade involved an aggregate capital investment of
approximately $12 billion.

But many of the loans poured into natural resource
exploitation have become soured, thus bankrupting many Indonesian
banks.

It took the Indonesian government several years and billions
of dollars in public money to get straighten out these bad loans
and to reform the banking system. Learning lessons from this
episode and trying to prevent these events from happening again
therefore, is of the utmost importance. If not, problems with bad
loans and the financing of non-sustainable forms of commodity
production will resurface.

It is thus very important that BI, the Indonesian banks'
supervisor, issue a regulation that gives directions to banks on
how they should rate the quality of their loans. The regulation
lists a number of aspects of the client's business, which need to
be assessed by the bank. When a client scores negatively on one
or more aspects, the bank runs a large risk of ending up with a
non-performing loan when it lends to this client.

What is most significant here, is that BI explicitly lists
"measures taken by the debtor to conserve the environment" as one
of the issues that needs to be taken into account by the bank.

BI clearly acknowledges that companies that do not pay
attention to their environmental behavior are more likely to
become bad debtors and therefore should be avoided.

Outside Indonesia, several commercial banks have developed
detailed forest, plantation and mining policies over the past few
years. According to the policies, these banks strive to finance
only companies which care for High Conservation Value Forests,
minimize their environmental impacts and respect the rights and
needs of local communities.

Building upon its existing regulation and information from
overseas, BI has the opportunity to further develop world-class
standards and procedures on assessing the social and
environmental behavior of commodity-producing companies.

In addition, BI's work can be strengthened by relevant
ministerial agencies (i.e. the Ministry of the Environment, the
Ministry of Forestry, etc.) and environmental and social
organizations. They can contribute to the assessment of impacts
on commodity-producing sectors, as well as helping the
identification of company initiatives that merit financing and
those that need to first adjust their business plans and
policies.

Avoiding future bad loans and banking crises as well as
environmental destruction and social conflicts needs to be
everyone's mutual interest.

Jan Willem van Gelder is a financial sector specialist with
Profundo in the Netherlands. Fitrian Ardiansyah is a program
coordinator for World Wide Fund for Nature (WWF) in Indonesia.