Enhancing Sustainable Banking Practices: Implementing the Besgi Framework to Indonesian Bank

: Climate change, a global issue largely caused by human activities, is now beginning to be addressed by the G20, including financial institutions. Indonesia, as part of the G20, is implementing a sustainable finance program to improve the financing, durability, and competitiveness of financial services institutions. This study evaluates the adoption of sustainable banking practices in Indonesia within the context of global climate change initiatives. Using the Banks’ Environmental, Social, Governance, and Indirect Impact (BESGI) framework, which provides a comprehensive assessment of banks' ESG performance using the Multidimensional Synthesis of Indicators (MSI) aggregation method. The BESGI performance of 14 Indonesian banks from 2020-2022 was assessed, revealing varying results of fluctuating data with Mandiri scoring the highest in year 2021 and BTN the lowest in year 2020. The findings indicate a growing emphasis on sustainable finance within the Indonesian banking sector in terms of financing and investment. The BESGI Score has insignificant results on banks’ performance and stability. However, further research is essential to comprehend the implications of these practices on the performance and stability of banks.


BACKGROUND
The United Nations report in July 2023 indicates that the era of global warming has officially ended, and the era of global boiling is starting.The average surface temperature during the first three weeks of July reached a record high of almost 17˚C, becoming the hottest month in human history.The report highlights the need for global action on emissions, climate adaptation, and climate change, including reaching net zero emissions by mid-century.Indonesia signed the Paris Agreement in 2016, setting a Greenhouse Gas emission reduction target of 29% unconditional (own effort) and 41% conditional (with adequate international support) by 2030.The government has incorporated the sustainable development framework into its Medium and Long-Term Development Plan, which includes four aspects: solid political and legal institutions, improved community welfare, advanced economic structure, and preservation of biodiversity.To achieve an economic growth average of 5.4-6.0 percent per year throughout 2020-2024, financing of investment needs is pursued through deepening the financial sector, increasing financial inclusion, expanding financial products, developing financial sector infrastructure, and optimizing alternative financing.Otoritas Jasa Keuangan (OJK) plays a role in achieving this commitment through its sustainable finance program, which seeks to increase financing and the durability and competitiveness of financial services institutions.The Sustainable Finance Roadmap sets forth the end goal of sustainable finance in Indonesia for the medium term (2015-2019) and long term (2015-2024) by the financial services industry under OJK's supervision.Sustainable finance refers to financial services that integrate environmental, social, and governance (ESG) criteria into investment decisions, lending practices, and other financial activities.The recent initiative of OJK to optimize alternative financing by composed Indonesia Green Taxonomy 1.0 in collaboration with 8 ministries and other parties in early 2022.This dynamic/living document is meant to develop standard definitions and green criteria from economic sector activities that support climate change mitigation and agenda in Indonesia.An important factor in evaluating and measuring sustainable finance is the ESG score.ESG ratings for companies that issue securities on the financial markets have become very popular recently.These ratings are typically developed by organizations with expertise in gathering and analyzing data on the sustainability aspects of business operations, based on, among other things, the content of both public and private corporate documents, meetings with management, reports from supervisory authorities, reports from NGOs, and newspaper articles (Ielasi et al., 2023).The different methodological choices regarding the indicators and the pillars to be included in the measure, the way to weigh them, and the normalizing process to apply to produce a wide range of metrics, with a low level of correlation (Berg et al., 2022;Hughes et al., 2021).The second reason why results obtained by literature that refer to ESG scores produce conflicting results is related to how the scores are applied in the analysis.The effectiveness of the scores to proxy different corporate results can be affected by the scope of the analysis and the original purpose of the ESG rating companies (Micheal E. Porter et al., 2019).Ielasi et al. (2023) argue BESGI Framework can cover ESG rating specifically for the bank sector.The BESGI score offers a more tailored and comprehensive assessment of banks' ESG performance, considering both direct and indirect impacts, and utilizing a specific methodology for the banking industry.Furthermore, there was various research that found a relationship between ESG scores and with bank's performance and stability.The positive impact of a higher ESG score is meant to encourage banks to increase ESG score that relates to better profitability ratios such as net interest margin and better stability ratios such as z-score.By utilizing new methods of scoring, this research also tries to find the relation between the BESGI score with banks' performance and stability.

SUSTAINABLE FINANCE IN INDONESIA
OJK certainly has the role to realize the commitment through a sustainable finance program.The program is implemented through cooperation with various parties to create financial support for institutions performing sustainable finance principles.The sustainable finance program is not only intended to increase financing but also to enhance the resilience and competitiveness of financial services institutions.Furthermore, to achieve it through systematic measures, OJK has cooperated with several related institutions to draft a Sustainable Finance Roadmap.The roadmap is intended to explain targeted conditions about sustainable finance in Indonesia for a medium-term period (2015-2019) and a long-term period (2015-2024) for the financial services industry under OJK`s supervision, also to set up and create a milestone of improvement for sustainable finance.This roadmap will function as a reference for OJK, practitioners in the financial The Phase II Roadmap (2020-2024) focuses on creating a comprehensive sustainable finance ecosystem that involves all related parties and promotes cooperation at various levels.To accelerate ESG implementation, we need to prepare initiatives that support innovations that are in line with the Sustainable Development Goals.This is the foundation for the Sustainable Finance Roadmap Phase II (2021 -2025), which has become an integral part of the blueprint for the future development of Indonesia's financial services sector.The sustainable finance initiative developed through the Roadmap Phase II will integrate seven major components into one ecosystem.The key to a successful sustainable finance ecosystem is based on developing and implementing all seven supporting elements.However, priorities are needed to implement ecosystems in the phase II Roadmap, which include: 1. Development of a green taxonomy, which aims to classify sustainable financing and investment activities in Indonesia.This classification is the basis for all stakeholders in Indonesia in carrying out sustainable economic activities.The formulation of the green taxonomy is carried out through the formulation of a national task force of sustainable finance composed of relevant ministries/institutions and related stakeholders.The taxonomy will accommodate the overall existing guidelines regarding the green sector.
2. Implementation of ESG aspects into risk management to increase resilience and mitigate environmental and social risks that may affect the financial industry's business processes.This effort is carried out through reporting on environmental, social, and governance aspects, developing key performance indicators, and supporting increasing the overall capacity of human resources.
3. Real program development is intended to present success stories of innovative green scheme development to be replicated to enhance the role of the financial industry in sustainable financing.The implementation of real programs is carried out in collaboration with related ministries/ institutions and other stakeholders.This is in line with the development of the government's leading economic sector and serves as the basis for further development of green financing schemes.

THE BESGI FRAMEWORK
Compared to traditional ESG scores, the BESGI score developed by Ielasi et al. ( 2023) is specific to the banking industry not just for the weights assigned to indicators, but for the main contents.The score is measured by considering the structural features of the financial sector, and peculiarities of bank products/services, also considering the shared regulation of the field in terms of reporting and accounting (Finger et al., 2018).It directly accounts for industry materiality, thanks to the choice of indicators and areas that are more relevant and material to companies within the financial industry.The BESGI score presents other originality terms.The contribution of this study is then manifold.The large number of indicators and granularity in the data used by ESG rating agencies highlights how the calculation of the traditional scores typically requires the strong contribution of the companies being evaluated which can affect the results.On the other hand, the BESGI score is built on public information, and it aims to be a model applicable to all banks, national and international, characterized by different legal forms and sizes.The model variables are selected considering the information that a bank usually makes available in public documentation making it possible to apply the model also to non-listed companies, for which no other assessments are available.Most indicators included in the methodology are taken from the global reporting standards issued by the Global Reporting Initiative.The model is thus highly replicable.The number of indicators within the BESGI scoring model is quite low compared to traditional ESG scores to avoid flattening results and to better assess the degree of heterogeneity of the banks' performances in the various pillars investigated.Indicators are specifically selected, as well as the areas.Given the peculiarities of the banking industry and their role in capital allocation, the BESGI score also includes an assessment of the indirect impacts resulting from banks' financing and investing activities.To evaluate the overall ESG engagement, the BESGI scoring model, unlike other tools such as scoreboards of indicators or other indices, measures simultaneously the bank's internal processes and behavior in terms of ESG issues, and the attention paid by the bank to the level of sustainability of the counterparties that it contributes to finance.To the best of our knowledge, the BESGI score is the first model to include indicators specifically aimed at capturing the indirect impacts of bank activities.Lastly, the BESGI score contributes to the discussion on the methodological approach to be applied to the calculation of sustainability scores, proposing an innovative methodology that allows to overcome some limitations of the traditional ESG scoring models: this study employs the Multidimensional Synthesis of Indicators (MSI) aggregation method to summarise indicators into a one-dimensional value (M.applying this methodology, the aggregation of areas avoids some of the common pitfalls of composite indices, such as the use of the arithmetic mean, in which the marginal contribution of one dimension remains constant both as the dimension itself varies and as all other dimensions vary.

SUSTAINABLE FINANCE, BANKS' BUSINESS MODELS, AND REGULATION
The importance of sustainable finance incorporates environmental, social, and governance (ESG) principles into business decisions and investment strategies.Banks are shifting towards sustainability and responsible financing to meet present needs without compromising future generations' needs.They are incorporating new models and frameworks to assess environmental, social, and governance impacts.These banks are tailoring their models to regional sustainability needs and regulations, ensuring long-term viability and responsible business practices while maintaining financial stability.
According to Sudrajad and Hübner (2018), research conducted in the ASEAN banking sector found the trend to shift to nontraditional income channels through mostly fee and to some extent trading income sources, where both items exhibit a slight upward trend.The non-interest income components comprise fees and commissions, trading and derivatives, and other non-interest income.Non-deposit short-term funding comprises deposits from banks, repos and cash collateral, and other non-deposit short-term funding.
On the bank funding side, a slightly positive trend is also observed in all elements of non-traditional short-term funding.Banks are crucial financial institutions but often fail due to a lack of capital reserves (Sudrajad, 2021).To maintain financial stability, prudential regulation and supervision of banks are the main objectives of the three-pillared Basel framework.Although sustainability isn't specifically addressed by the Basel framework, it's becoming increasingly clear that sustainable finance and environmental, social, and governance (ESG) factors are critical to the financial system's long-term stability.The evolution of Basel regulation described by Sudrajad (2021) started in 1987, The Basel Committee on Banking Supervision (BCBS) aimed to harmonize capital standards in the banking industry, leading to the Basel I Accord in 1988.This agreement aimed to strengthen international banking system stability and create global regulatory standards.The key achievement of Basel I is the "bank capital ratio," which defines bank capital into core and supplementary capital.Credit risk is determined based on banks' riskweight assets, with a minimum of 8% of total capital as risk-weighted assets.
In 2004, Basel II was proposed to improve regulatory capital requirements by considering financial innovation and risk sensitivity in calculating risk-weighted assets.It proposed two methodologies: the internal rating-based approach (IRB) and the standardized approach (SA).Basel II strengthened regulation in the regulatory capital requirement, requiring banks to hold more capital for highrisk portfolios and providing guidance for securitization in the rapidly growing banking industry.The revised framework consists of three pillars: capital charge, regulatory flexibility, and market discipline.

Figure 1. Research Design
The BESGI Model refers to the aggregation method measured using Multidimensional Synthesis of Indicators (MSI).This method of aggregation is an approach that has characteristics similar to the geometric mean, but which overcomes some important limitations.The main idea is that the weighting of dimensions is implicit in the data and the aggregation is based on the bank's achievements in each dimension, rather than being predetermined.The first step to measure the BESGI score is to standardize each indicator using the max-min method.Then we aggregate indicators at the dimension level using the arithmetic mean of the scores and then aggregating dimensions at the area level.Subsequently, the areas were aggregated in the BESGI Score using the MSI method.The formula for calculating the BESGI score is as follows: Where: BESGIit is the BESGI score for bank i in year t.xjit is the standardized value of indicator j for bank i in year t.μ it is the number of dimensions for bank i in year t.After the BESGI Score obtained for each bank annually, then the author try to measure the effect of BESGI Score to banks' performance and banks' stability using Regression econometric model is written as: BESGI Score is compiled from 27 indicators which consist of 8 dimensions, 5 areas, and 2 domains.To observe more in detail, Table 2 summarises the main results for the BESGI score and its subindices and dimensions, by year.The average BESGI Score has generated fluctuating data with the highest in the year 2021.The highest domain score is generated from the indirect impact index, with the investment sub-index being the highest and most stable in all three years.This result provides insight that the Indonesian banking sector is concerned more with investment.In the ESG index (direct impact), the BESGI Score includes several indicators that relate to bank operational activities and management.Concerning the direct impact index components, the governance sub-index is the highest, while the environment subindex remains the lowest in all three years.This result is in line with the Bumi Global Karbon reports on the news by Isjwara, R.
(2020) that Indonesian banks put more emphasis on governance disclosure, such as risk management, and less on environmental and social aspects.On the other hand, some indicators in environment components are not provided by Indonesian banks with values of 0. For instance, the lowest score of environment components was obtained from the indicator: amount of waste produced per employee, only BJB provided the data as needed.Another indicator is: the percentage of electricity from renewable sources, only 4 banks (BCA, BNI, Danamon, and UOB) have shifted electricity usage resources to solar panels.The other banks' effort is still to reduce electricity usage.
After gathering the BESGI score, the authors tried to see its effects on banks' performance and stability using regression on the equation.Banks' performance included ROA, ROE, and NIM, while banks' stability included z-score and NPL.
The Basel II framework aimed to improve regulatory capital requirements and address financial innovation after the first accord.Implemented in 2006 and 2007, it failed to prevent the 2008 global crisis.The Basel III framework aims to strengthen global capital and liquidity regulations and improve the banking sector's ability to absorb shocks from financial and economic distress.It includes an extra layer of common equity, a countercyclical buffer, a leverage ratio, liquidity requirements, and a proposal for "too-big-tofail" banks.Sustainable finance principles align with the Basel Pillars in several ways:1) Pillar 1 (Minimum Capital Requirements): Sustainable finance practices can influence the minimum capital requirements by considering environmental and social risks in the assessment of credit, market, and operational risks.This aligns with the need to incorporate ESG factors into risk management practices, potentially impacting the calculation of capital reserves.2) Pillar 2 (Supervisory Review Process): The supervisory review process under Pillar 2 involves evaluating a bank's risk management processes.Integrating sustainable finance principles into risk management aligns with the supervisory review process, as it demonstrates a comprehensive approach to identifying and managing risks, including those related to environmental and social factors.3) Pillar 3 (Market Discipline): Sustainable finance practices can enhance market discipline by promoting transparency and disclosure of ESG-related risks and opportunities.This aligns with Pillar 3's focus on disclosure and market discipline, as it provides stakeholders with relevant information to assess a bank's risk profile, including its exposure to environmental and social risks.The BESGI framework incorporates the third Basel pillar as indicators measured in the transparency & and disclosure dimension which includes as governance area.study will use the BESGI framework to determine BESGI's scores and then a regression model to examine the effect of BESGI scores on banks' performance and stability, in this case, BESGI Scores from the results of calculation act as independent variables and dependent variables such as Return on Asset (ROA), Return on Equity (ROE), and net Interest Margin (NIM) include as financial performance and Z-Score and Non-Performing Loan (NPL) include as financial stability.

Table 1 . Description of Variables Variable Definitions Dependent Variable (Financial Performance)
/σ, where k is equity capital as a percent of assets, µ is returned as a percent of assets, and σ is the standard deviation of return on assets as a proxy for return volatility NPL Non-performing loan to total gross loan Figure2shows the BESGI Score for a total 14 banks.Upon analyzing the graphical representation based on Figure IV.10, it is observed that the Indonesian banks with respect to sustainable finance appear to be fluctuating.OJK has required financial industries to report sustainability reports since 2019 through POJK No. 51/POJK/03/2017 (Departemen Penelitian dan Pengaturan Perbankan Otoritas Jasa Keuangan, 2018) however, the research findings that the reporting within the BESGI framework has an upward trending from year 2020 and reached the highest in the year 2021, then downward trending to year 2022.According to IFC (2022), Indonesia's financial institution coverage in 3 framework areas which are climate risk management, ESG integration, and financing sustainability sequentially, is still lacking in tracking, reporting, and disclosure.