The rapid development of palm oil plantations has raised global concerns about the imbalance between the economic gains, and its environmental and social costs. Despite the sector employing millions of people and having become one of the major components of the Southeast Asian economy, the devastating reality of the palm oil industry inflicts the deforestation, loss of biodiversity and wildlife, land disputes, unethical labor practices, and violation of local communities’ rights. In a palm oil plantation area in Central Sulawesi for instance, palm oil plantation was found to be the reason not only for land degradation and labor rights violations, but also seen to affect water supply and crop production of surrounding communities (ResponsiBank, 2015).

To address the sustainability issues in the palm oil sector as well as to enhance market trusts in Indonesian palm oil products, the Government of Indonesia through the Ministry of Agriculture has issued the ‘Indonesia palm oil certification scheme’ (ISPO/ Indonesia Sustainable Palm Oil) in 2011. This standard has become a mandatory requirement for all palm oil producers in Indonesia, that has to be also applied for smallholder farmers. The legal standing for the ISPO system was enacted by Presidential Regulation (Perpres) No. 44 Year 2020 that specifically focuses on the organization, acceptance, market competitiveness, participation, mentoring and surveillance, and sanctions. Regardless, the scheme has gained criticism regarding its lack of transparency and accountability, as well as unclear sustainability criteria and weak enforcement. Compared to the internationally acknowledged standards, such as RSPO (Roundtable on Sustainable Palm Oil), ISPO criteria are strongly aligned with national, legal and regulatory requirements. Favorable local government regulations drive to more vague requirements for social and environmental impact assessments. On the other hand, efforts to uphold sustainability standards from the downstream company i.e. financial institutions that finance the industry remain challenging.

Most palm oil companies are dependent on financial institutions to finance their expansion plan. Being a capital-intensive industry, establishing plantations requires a huge amount of financing upfront to clear the land and build infrastructures, such as mills and refineries to process the palm fruits. Once the palm trees were planted, it took three to five years to yield fruit and seven years to reach maximum production. Over the past decade, more than $50bn has been invested in the Malaysian and Indonesian palm oil sectors, where commercial banks are important sources of capital (Banktrack, 2018). This highlights the critical role that financial institutions can play in ensuring that significant steps are taken towards ensuring a responsible palm oil sector, by setting ESG (Environmental, Social, and Governance) requirements and sustainability standards for the provision of the financial services. In practice, however, only financial incentives  tend to drive the decision-making process within the financial institutions.

As Indonesia is still laying down the building blocks to establish a sustainable financial system, notable milestones have been achieved over the years towards making Indonesia one of the more advanced countries in implementing sustainable finance regulations. In 2014, the Indonesian Financial Services Authority (OJK) published a Roadmap to Sustainable Financing 2014-2019 suggesting steps for the financial service industry to mitigate the impact of climate change and shift toward a competitive low-carbon economy and environmentally friendly investments that are pro-growth, pro-jobs, pro-poor, and pro-environment. In 2017, OJK has issued the OJK Regulation (POJK) No. 51/2017 on an Action Plan for Sustainable Finance and POJK No. 60/2017 which set out the standards for green bond issuance in the country. However, the progress implementation of sustainable financing in Indonesia has unfortunately been  below expectations considering the enormous potential.

Last year, OJK released a guidance book for financial institutions that provide information about palm oil financing requirements in-line with sustainability standards. Regrettably, this guidance is only applied on a voluntary basis. The situation is that financial institutions, especially those originated in Asian countries do not have adequate ESG policies in financing the palm oil industry (CIFOR, 2018). Even worse, in Indonesia none of financial institutions have disclosed information regarding their sectoral lending policy (ResponsiBank, 2018), including in high-risk sectors such as palm oil. The absence of transparency and accountability on the lending policies and implementation remain a major barrier for financial institutions to play a major role in driving a sustainable palm oil sector. On the other hand, the lack of mandatory requirements for financial institutions to adhere to ESG criteria for loan disbursement has enabled financial institutions to be exposed from the risk of financing unsustainable business practices.

A recent study from Fair Finance Asia and Profundo showed that in the period of 2014-2019, US$44,4 billion of loans and underwriting services streamed into selected agriculture companies in Indonesia, including major players in the palm oil industry such as Astra Agro Lestari, Golden Agri Resources, and Indofood Sukses Makmur. A quarter of the financing was provided by Indonesian financial institutions, while a significant amount of financing reaching almost 60% of financing to the selected companies came from financial institutions based in other Asian countries such as Japan, Thailand, Malaysia, Singapore, and the Philippines. Palm oil industry remains one of the biggest credit portfolios for Indonesia’s top four financial institutions: BRI (Bank Rakyat Indonesia), Bank Mandiri, BCA (Bank Central Asia), and BNI (Bank Negara Indonesia). However, Mizuho Financial from Japan became the largest creditor providing US$3,6 billion worth of financing in the agroforestry sector, followed by Bank Mandiri (US$2,8 billion) and Krung Thai Bank (US$2,4 billion).

Huge amount of financial flows across Asia in the agroforestry sector, has served an opportunity for financial institutions to promote comprehensive sustainability standards across the supply chain by implementing much more prudent screening and due diligence process before issuing a loan. Financial institutions should incorporate sustainability commitment and compliance to the regulation while playing a significant role to promote inclusive business in the companies it financed. This is critical not just to ensure the avoidance of  financial risk but also to build its reputation as a champion on sustainable business practices. For almost two decades, integration of ESG policies into the financing and investment decisions of Financial Institutions stimulated by financial sector initiatives as Equator Principles and Principle for Responsible Investment has evolved to tackle reputational, financial, and compliance risk associated with controversial sectors. However, enthusiasm from investors to opt for sustainable investment remain low. As a highly regulated sector, financial sector actors need regulatory pressures from the government to be willing to emphasize ESG criteria following financial return consideration in its lending and investment policies. Nevertheless, the demand for sustainable financing should predominantly be driven by private entities, and sustainability should not merely be considered as a standard but rather as the way of doing business.

Furthermore, Comparison of policies and practices among financial institutions worldwide should be done to create a peer-learning ecosystem, creating a race to the top for financial institutions to deliver sustainable financing. With the financial threat that comes with the impacts of irresponsible businesses, improved understanding of the risk of business as usual, both for financial institutions and the companies they invest in, should be inevitable. As demand for responsible and sustainable investments keep growing, Financial Institutions should improve their resilience and competitiveness to face the challenges of an increasingly dynamic banking world by ensuring that people and the planet are protected from poverty and inequality as well as ascertain that they are a part of the solution to protect the earth from climate change risks due to forest degradation.

A blog by Dia Mawesti,  Sustainable Development Officer, Perkumpulan Prakarsa