Integration of ESG Factors into the Credit Risk Assessment Process - A Framework for Islamic Banks

Sustainability issues have gained prominence in recent times, and as a result, the financial sector is being pressured to adopt sustainability practices in its operational activities. In this manner, the integration of ESG factors into credit lending has become crucial as these factors can impact the debt payment capacity of corporate customers. However, much of the focus in current literature has been devoted to the environmental dimension of ESG. Consequently, the social and governance dimensions lack quantitative indicators for risk assessment purposes. This paper has attempted to develop such quantitative indicators for the social and governance dimension that are relevant to the credit risk assessment of corporate customers by Islāmic banks. The study is based on primary and secondary data in which elite interviews were conducted to obtain the primary data. Charmaz’s coding method was used for the elite interview analysis, while content analysis was employed to extract relevant data from secondary sources. The analysis revealed that banks are still in the early stages of ESG factor integration, and the social and governance dimensions are assessed qualitatively owing to the challenges arising from the field being very new. Considering the importance of this area, the paper recommends that Islāmic banks set-up ESG committees and hasten the ESG factors integration process into credit lending.