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Abstract

Indonesia’s Financial Services Authority (OJK)’s sustainable finance roadmap, phases I and II, primarily aims to facilitate sustainable development by integrating economic, social, and environmental considerations into financial policies. A special objective is to promote the development of green financial products and services. This policy allows banks to mitigate reputational and regulatory challenges. Nevertheless, the prompt implementation of green credit may entail transition risks, such as policy adjustment costs. A limited body of research examines the direct relationship between green finance and bank risk, particularly in the context of sustainability mandates. This study analyzes the influence of green finance on banking risk measures by Z-score in relation to regulatory oversight of green finance. Green finance is represented by three indicators: (1) green credit, (2) the proportion of loans allocated to micro, small, and medium enterprises (MSMEs), and (3) green activities.  This study employed a random-effect model on unbalanced panel data from 47 conventional banks from 2019 to 2023.      The results demonstrate no significant association between green credit and banking risk; MSME credit markedly elevates bank risk; and, although not yet substantial, ecologically sustainable practices appear to reduce risk. This discovery may reflect the preliminary stages of implementing OJK’s sustainable finance roadmap, which are generally characterized by elevated implementation costs and reputational risks that limit profitability. Therefore, the OJK must provide transitional incentives. Furthermore, enhancing the function of credit guarantee institutions in risk distribution, improving MSME literacy and governance, and executing more comprehensive MSME risk segmentation to prevent risk mispricing are essential.

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