The image of Islamic Banking system is increasing since the financial crisis in 2008. Islamic financial market activity as well as in some developed countries such as Australia, Bahamas, Canada, Cayman Islands, Danish, Guernsey, jersey, Ireland, Luxembourgh, Switzerland, United Kingdom, United States, and Virgin Islands also grow (Latifa and Mervyn 2001, p.
9).Base on Bank Indonesia report at the third quarter 2009, The Banker’s survey in 2009 showed that the asset managed by the 500 largest Islamic financial institutions in the world in 2009 grew 28. 6% compared to 2008 or from USD639 billion to USD822 billion. In Indonesia, Islamic Banking was began in 1992 with the establishment of Bank Muamalat Indonesia and followed by Bank Syariah Mandiri in 1999. Bank Indonesia statistic informed that position in March 2010 there were eight Islamic Commercial Bank, 25 Business Unit, and 143 Islamic Rural Bank (BPRS). Total number of Islamic Banking offices are 1499 units.Looking at the trend growth of Islamic banking institutions and the number of such offices, it seems that the market of Islamic Banking business in Indonesia grew rapidly. Particularly in Indonesia, a majority Muslim society Along with the rapid growth of Islamic Banking, there is the problematic application of the primary product of the Islamic Banking based on profit and loss sharing.
In Indonesia, based on the Act No. 7 of 1992 article 6, Islamic Banking is identical with the primary product profit and loss sharing. In a recent article (Rifki 2009, p.
01) Islamic Banking theory recognizes financing allocation into three types which are: (a) Equity-based financing; (b) Debt-based financing and; (c) Benevolent loan and service. Profit and loss sharing concept is included in the category of Equity-based financing. According Sunarto (2003, p.
24) transaction of Islamic economic system have two contract, tabarru’ (virtue) and tijarah (business). Tijarah contract is for business and business-oriented. Equity-based financing and Debt-based financing are included in tijarah category.
Amongst all kinds of financing, debt based financing is the most favorite one in particular Murabahah financing.Islamic Bank use it is because (a) Murabahah rate of return is predetermined, fixed and continues (b) Trade financing does not require much efforts to monitor (c) Risk of default is relatively low (Rifki. 2009, p. 102). Existing trends in some countries that apply Islamic Banking, Murabahah skim as secondary product with a certain margin has large portion, with an average 70% more. Likewise in Indonesia, the implementation of equity-based financing as a primary product of Islamic Banking has a smaller portion because it has a high risk.The cause of high risk is any asymmetric information between Bank/Owner of the funds (shahibul mall) and Client/Entrepeneur (mudharib). Antonio (2001,p.
90) said that there are four types of major contract in Equity-based financing which are Mudharabah (trustee partnership), Musharakah (joint venture), Muzara’ah (harvest yield profit sharing), and Musaqot (plantation management fee based on certain portion of yield). But the principle of the most popular and widely used by Islamic Banking in Indonesia from Equity-based financing is musharakah and mudharabah.Focus of this paper is how to solve problems of asymmetric information on Equity-based financing product specifically musyarakah and mudharabah which if not mitigated will create moral hazard for entrepreneurs and at the end will harm the development of Islamic banking. Islamic Economic Business as part of economic activity is always a vital role in human life throughout the ages. Economic interests will influence the behavior for all levels of the individual, social, regional, national, and international. Muslims have long been involved in economic activity since the fifteenth century ago (Merza 2006, p. -2). The phenomenon is not a strange thing, because Islam encourages Muslims to conduct business activities in order to meet their social-economy needs.
Islamic economic that has been running currently in Indonesia known as Islamic Economic System. Merza (2006, p. 5) explained that the Islamic Economic System has several goals: 1.
Economic Welfare in the framework of the Islamic moral norms. 2. Form a community with a solid social order, based on justice and universal brotherhood. 3. Achieving the distribution of income and wealth in a fair and equitable. 4.
Creating individual freedom in the context of social welfare. Paradigm of Islamic Economic System is different from conventional economics. Paradigm of Islamic economic system is not a secular, free values, materialist and Social-Darwinism. But Islamic economic system based on a number of concepts which tend to be rooted in his doctrines.
Islamic economic system provided the main interest in moral values, human brotherhood and social and economic justice. Unlike the concept of Marxism and Capitalism are not relying on the state nor the market to realize its vision (Chapra 2001,p. 59).Thus the paradigm of Islamic economic system leads to better integrate the role of values and institutions, markets, families, communities and countries to ensure the realization of prosperity for all. This emphasizes the importance of social change through improving individual and society, without causing any unfairness in the market and the state. Characteristics of Musharakah and Mudharabah Musyarakah is an agreement between two or more parties to a particular business in which each party contributes funds or expertise with the agreement that the benefits and risks will be shared in accordance to an agreement (Antonio 2001, p.
0-91). Musyarakah financing is usually applied to projects where the client/entrepreneur and the bank/owner of the funds together to provide funds to finance the project. After the project is completed, client/entrepreneur return the funds together for an agreed outcome for the bank. Bank as the owner of the fund in this case is known as a business partners, is eligible to participate in company management. But the participation of the Bank is not a necessity. The parties can divide the work to manage the business according to the agreement, and they can also request a salary for heir effort and expertise devoted to the business. However, in practice in Indonesia, the Bank did not participate in the management of the business because of oddity and have the confidence to client/entrepreneur. In musyarakah, profit divided by agreement of the parties, while the loss will be shared in proportion to equity participation of each party (Zainul.
2010). Slightly different from the musyarakah, mudharabah is an agreement between two parties whereby the business first bank/owner of the funds to provide full of financial capital (100%), while client / entrepreneur to provide expertise.Mudharabah business profits divided by agreement as outlined in the contract, whereas if the loss is borne by capital owners during the loss was not due to negligence of the client/entrepreneur. If the losses due to fraud or negligence of the client/entrepreneur, then the client/entrepreneur will be responsible for losses (Antonio 2001,p. 90-91). Here will appear the asymmetric information between client/entrepreneur and bank/owner of funds. The asymmetric information being happen because of the bank has less information on the project and the client/entrepreneur not disclose the profit or income of the project.
Generally mudharabah divided into two kinds; mudharabah muthlaqah and mudharabah muqayyadah. Mudharabah muthlaqah is a form of cooperation between the bank/owner of the funds and client/entrepreneur that broad in scope and not limited by the specification type of effort, time, and the business district. Unlike the mudharabah muqayyadah or also called the restricted mudharabah which restricted to the type of effort, time, or place of business (Zainul. 2010). In addition, in banking applications, mudharabah can be implemented in products funding and financing.
In this paper, mudharabah that will discussed is mudharabah that be implemented in financing product. Musyarakah/Mudharabah Risk Risk inherent in the musyarakah and mudharabah in financing product is relatively high. Antonio (2001, p. 93-97) has shown the risk: 1.
Side streaming Side streaming in question is client/entrepreneur use the funds not referred to in the contract. It can happen because customer from abusing the trust that has been given by the bank. This is because the character of client/entrepreneur is not good. 2. Negligence and willful misconductNegligence and willful misconduct can occur if client/entrepreneur do not have the expertise and good management.
Or it could be if the client/entrepreneur is deliberately causing speculation beyond the ability of large losses. Speculation could happen because there is an element of greed will benefit. For example doing or promising to complete the project although have a limited resources or collusion with the project committee which causes other cost increase and erode profits.
3. Concealment of profits by the client/entrepreneur The basic concept of mudharabah and musyarakah is profit and loss sharing system.According to PSAK 59 about Islamic Banking accounting, there are two types of profit sharing, through the gross and net profit sharing. In this concept, bank/owner of the funds and client/entrepreneur agree in advance how many percentage of gross profit or net operating profit to be distributed. Obviously the revenue of each month not same and tend to fluctuate. This characteristic is the real nature of the concept of profit and loss sharing. However, in practice if the customer is not good moral and are not honest in reporting its financial results to the Bank, the concept profit and loss sharing would be detrimental to either party.Incompatibility of information or asymmetric information that arises quite is dependent on the moral client/entrepreneur.
Moral hazard is a special case of information asymmetry, a situation in which one party in a transaction has more information than another. The party that is insulated from risk generally has more information about its actions and intentions than the party paying for the negative consequences of the risk. More broadly, moral hazard occurs when the party with more information about its actions or intentions has a tendency or incentive to behave inappropriately from the perspective of the party with less information.Moral hazard arises because an individual or institution does not take the full consequences and responsibilities of its doings, and therefore has a tendency to act less carefully than it alternately would, leaving another party to hold some responsibility for the consequences of those actions (wikipedia. 2010).
Because of these risks, the Islamic Banking tend to be reluctant to distribute the product musyarakah and mudharabah. Hadi Purnomo, Head of Corporate Banking at the Bank Syariah Mandiri said: “Skim of musyarakah and mudharabah have high risk for the banking industry.Currently, it is difficult to find a client / entrepreneur who have the honesty and high integrity.
Client/entrepreneur tend to keep the benefit for his own and always said suffering from losses because of business risks. Actually it is common if the loses is caused by client/entrepreneur managing a busines. On the other word, the client/entrepreneur want to pay cheaper to the bank. “(Personal Interview, June 1, 2010). Based on the statistic of Bank Indonesia in March 2010, the portion of musyarakah dan mudharabah financing is smaller than murabahah. It is shown in the table below: In. Rp Billion Contract |2005 |2006 |2007 |2008 |2009 |Maret ’10 | |Mudharabah |3. 124 |2.
335 |4. 406 |7. 411 |10. 412 |11. 216 | |Musyarakah |1. 898 |4.
062 |5. 578 |6. 205 |6. 597 |6. 716 | |Murabahah |9. 487 |12. 624 |16. 553 |22.
486 |26. 321 |28. 269 | Source: Bank Indonesia statistic, March 2010.From the table above, murabahah portofolio is higher than musyarakah and mudharabah. It is contradictive with the nature of Islamic Banking system which have the primary product in profit and loss sharing concept, musyarakah and mudharabah. Reducing Asymmetric Information As mandated in the Act No.
7 of 1992, article 6 that the primary product of Islamic Banking is profit and loss sharing concept. This concept contains the following advantages (Antonio 2001. p. 93): 1.
The bank/owner of funds will enjoy an increase of profit when business of client / entrepreneur increase. . The Bank is not obliged to pay a certain amount of funding and equipment to customers, but adjusted earnings / results of operations of the bank. So that banks will not have experienced in the negative spread. 3. Principal return base on client/entrepreneur cash flow.
4. The principle of profit and loss sharing, musyarakah and mudharabah, is different with the principle of conventional fixed rate. The conventional bank will charge customers a fixed rate regardless of how profitable client/entrepreneur, also even though losing money and in the economic crisis situation.Therefore, it required an effort to minimize the asymmetric information so the profit and loss sharing concept be growing rapidly. There are several ways that can do: 1. Involvement of the bank or third party as an independent party in the client / entrepreneur business.
The argument that the involvement of the bank or any third party representing the banks in the implementation of such efforts made by Mervyn and Latifa (2001). They argue that in order to assess the viability of the project, the bank should consider this particular expert.Their expertise can be used not only for project appraisal, but also for guidance and advice on project management. This is a common thing done by the Islamic Banking in Iran. In Indonesia it has been run by some Islamic Rural Bank (BPRS), but has not been carried out by Islamic Commercial Bank (BUS). 2. Building the Islamic principles. Relation between the bank/owner of fund and the client/entrepreneur needs to be based by Islamic values that contain ethics.
That value will prevent the all party acts contrary to what can be accepted by society.Mainly, the building process through the exemplary ethic is by Bank Officer. 3.
Provides financing to companies which listed on the stock market. Companies that listed in stock market must provide disclosure information, because the company as a public company. Disclosure of this information will allow officials to evaluate the performance of the bank customers.
4. Banks have access anytime to the company’s accounting application/ mirroring application of accounting firms. Access to this information can be made if the client/entrepreneur has implemented the SAP system.The SAP system allow key employee that may be opening a company’s internal corporate database application anywhere and anytime. If the bank/owner of fund was granted the right access the transparency of financial statements can be identified by the bank 5.
Client/entrepreneur give some collateral to the bank. Collateral in here it’s mean as a moral obligation. Client/entrepreneur will think twice or third if he want doing moral hazard.
Conclusion Islamic banking is growing rapidly. However, rapid growth of Islamic banking is not matched by the rapid growth of Equity-based financing product as widely known with musyarakah and mudharabah.One of the main obstacles is the existence of asymmetric information that can lead to moral hazard on the client. Based on the above description has been clear that the asymmetric Information can be minimized by several way; involvement of the bank or a third party appointed by the bank in managing the business, continually build on shariah principles, provides financing to companies listing on the stock exchange, the bank have access directly to the customer database system, and client/entrepreneur give collateral to the bank as a moral obligation.Reference: Antonio, M. Syafi’i. ,2001.
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1. Bank Indonesia,2009. Development of Global Islamic Financial Market. Jakarta: International Bulletin, 3rd Quarter. Chapra, M. Umer. ,2001. The Future of Economics: An Islamic Perspective.
Translate by Sharia Economics and Banking Institute. Jakarta: SEBI Press. p. 59.
Gamal, Merza. 2006. Social and Economic Dynamics Model of Islam; Solutions Development Sustainable ; Equitable Welfare. Pekanbaru: UNRI Press. p. 1-5. Ismail, Rifki.
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org [Accessed on 01 June 2010 at 17. 30 pm]. Zulkifli, Sunarto. ,2003. Practical Guide of Islamic Banking Transactions.
Jakarta: Zikrul Hakim. p. 24. ———————–  Student in MBA Sharia Banking and Finance, School of Business and Management, ITB