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.