INDONESIA: How Indonesia’s central bank is leading its green transition

Indonesia is one of the largest CO2 emitters in the world. But even though the country remains dependent on coal and has given mixed signals on phasing it out, Indonesia’s central bank has a clear mandate to develop green finance.

As a result, Indonesia stands out as a strong performer in the first East and Southeast Asia Green Central Banking Scorecard, despite having a lower GDP than China and Japan. It was one of the top performers in the region for its financial policy work and has coordinated with other institutions to adopt green policies.

This progress is partly due to the country’s financial sector omnibus law. Passed in 2023, the P2SK law gave the central bank a mandate to develop and regulate green finance, including the creation of a new green department. It’s one of the few central banks in the world with a clear green policy mandate.

“Because of this mandate, we have now many, many new green initiatives,” said Heru Rahadyan, deputy director at the financial inclusion and green economy department at Bank Indonesia (BI).

“We assume that banks need to proportionally recognise debtor carbon emissions as bank emissions,” he added.

This makes the banking sector one of the largest emitters of greenhouse gases, and as a result, financed emissions need to be reduced, he said. In other words, banks need to be a catalyst for reducing borrower emissions.

Transforming banks into green banks
BI’s ultimate goal is to transform its financial institutions into green banks. Part of that is creating a green work culture at the central bank such as encouraging staff to use public transportation, said Rahadyan.

All bank staff new hires have a mandatory green training, which is compulsory for existing staff to be promoted. There is also a research programme on climate issues,

BI has various green initiatives aimed at financing and debtors. Under its green financing objective, BI offers a reduction in reserve requirements of up to 50 basis points for banks that finance eco-friendly housing and EVs, and facilitates lenders to offer a 0% down payment for such loans.

Banks can also fulfil their inclusive financing ratio by investing in green and sustainable bonds that fund environmentally friendly projects.

A person walking from right to left in the middle of several rows of solar panels. Trees sit behind the solar panels and city buildings loom in the distance.

BI is also supporting the green transition directly by investing in green government sukuk, a type of Islamic bond, which are used as collateral. It has also integrated climate-related natural disasters into its economic analysis and has a climate-related stress test.

One of BI’s newest green initiatives is supporting SMEs to become green by providing research and support and connecting them with banks to help increase green funding.

“We want to transform SMEs to be green,” said Rahadyan.

Many of these initiatives are still new so there is no clear data on how effective they are, but Rahadyan says the initial growth is very promising, especially for green mortgages and electric vehicles.

The P2SK law not only created a green mandate but also required the various financial regulators to create a national sustainable finance committee to help coordinate regulatory efforts.

“This collaboration among the regulators is very critical,” said Rahadyan. “Sometimes it’s very difficult to align because we have our own agenda. For example, we want to collect some green data, and then [there’s a question of] who will do it, the FSA [Financial Services Authority] or the central bank? And then we have different interests with the data and so on”.

This new collaboration and joint committee is designed to help the entire financial sector move towards a green transition. That includes coordinating on its green taxonomy which is in its third phase and has been criticised for allowing some coal power plants to be considered transition activities. It is also creating a green calculator that businesses can use to report their carbon emissions based on IPCC recommendations.

BI already collaborates with the FSA on the climate-related stress tests. BI conducts top-down stress tests while the FSA conducts bottom-up stress tests, and they then compare results.

The central bank also collaborates on a regional level through the Association of Southeast Asian Nations (Asean). For example, Indonesia’s taxonomy is largely based on the Asean green taxonomy. And Asean’s guidelines on how central banks should address climate-related risks is “a very fundamental book for us,” said Rahadyan.

BI is also collaborating on developing an Asean green map and coordinates with research and training on various issues, including climate.

Indonesia’s green finance initiatives are just beginning
The green initiatives of BI are just the beginning, said Rahadyan.

“We have so many green initiatives right now but I think it’s still early stage because a lot of things need to be done,” he said. That includes building infrastructure and standards, and increasing public awareness which is one of the main challenges.

And many discussions are still ongoing, such as expanding the green taxonomy and determining who will verify sustainable disclosure standards.

Some of BI’s biggest challenges include aligning regulatory efforts and developing public awareness and verification standards for sustainability reporting, Rahadyan said. And while its taxonomy and disclosures are currently voluntary, there are plans to recommend they become mandatory.

“Indonesia currently [is focused] on housing and the electric vehicle,” said Rahadyan. Once there is a new reporting platform and agreements to make reporting mandatory, “then Bank Indonesia will expand our focus to other [green] areas”.