Dynamic ESG–NPF Interaction in Islamic Bank

This study investigates the dynamic relationship between Environmental, Social, and Governance (ESG) Disclosure and Non-Performing Financing (NPF) within the context of Islamic banking in Indonesia, with a specific focus on Bank Syariah Indonesia (BSI) during the period 2021–2025. As the largest Islamic bank in Southeast Asia, BSI plays acritical role in promoting sustainable finance aligned with Sharia principles. Amid rising expectations for ESG transparency and persistent credit risk challenges, this research explores whether ESG disclosure contributes to reducing credit risk, or if financial distress influences disclosure quality. Employing a quantitative time-series approach using the Vector Autoregression (VAR) model, the study analyzes monthly data on NPF and ESG scores derived from audited financial and sustainability reports. The results reveal a significant unidirectional relationship whereby improvements in ESG disclosure led to a reduction in NPF after a one to two-month lag, while NPF does not significantly affect ESG disclosure. Impulse response and variance decomposition analyses further support the lagged and cumulative impact of ESG practices on credit risk mitigation. These findings suggest that ESG disclosure in Islamic banks serves not only reputational and compliance purposes but also function as a proactive risk management tool. The study contributes to the growing literature on sustainable finance in Islamic banking and offers practical implications for regulators, financial institutions, and investors by highlighting the strategic value of ESG integration in promoting financial stability.