Have Islamic Microfinance Institutions In Indonesia Implement Risk Management?

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HAVE ISLAMIC MICROFINANCE INSTITUTIONS IN INDONESIA IMPLEMENT RISK
MANAGEMENT?
Muh Juan Suam Toro
Center of Islamic Economics Study
Universitas Sebelas Maret, Surakarta, Indonesia
Email: mjuanst@yahoo.com
Arum Setyowati
Center of Islamic Economics Study
Universitas Sebelas Maret, Surakarta, Indonesia
Email: arumsetyowati@yahoo.com
Arifuddin
Center of Islamic Economics Study
Universitas Sebelas Maret, Surakarta, Indonesia
Email: arifarifin81@gmail.com
ABSTRACT
Banking in Indonesia is highly regulated by Bank Indonesia as the central bank with the aim to prevent the failure of
the banking system and to guarantee the public funds are in the safe hands. At the micro level, there are many
financial institutions that serves as intermediary institution that operates like a bank, but not under the supervision of
the central bank. In addition, the rapid increase in the number of Islamic microfinance institutions (Islamic-MFI) in
response to the desire of the majority moslem population of Indonesia raised the question whether they apply the
principles of prudential banking. This study aimed to identify the risk management practices applied by Islamic
microfinance institutions and examines how the impact of these practices on financial performance. The population of
this research is Islamic-MFI. The sample of this research is Islamic microfinance institutions in the form of Baitul
Maal wal-Tamwil (BMT) and the Koperasi Jasa Keuangan Syariah (KJKS) in the area of Regency of Klaten,
Sukoharjo, Boyolali, and Karanganyar, Jawa Tengah Province. Descriptive analysis and regression analysis were used
to meet the research objectives. Descriptive analysis is used to describe the extent to which forms of risk management
practices carried out by Islamic microfinance institutions and regression analysis were used to analyze the relationship
between risk management’s understanding, identification, assessment, and monitoring and risk management practices
in Islamic-MFIs. The result showed that Islamic-MFIs have understood, able to measure, and monitor risk
management, but the ability to perform risk identification are still weak. The second result showed that Islamic-MFIs
have implemented risk management practices and credit analysis. There are relationships between ability to
understand, carry out assessment, and monitoring of risk management and risk management practices, but no
relationships for risk identification. Risks type faced by Islamic-MFI are credit risk, debt risk, liquidity risk, reputation
risk, and interest rate risk.
Keywords: risk management, Islamic microfinance institution, financial performance
BACKGROUND
The study of the microfinance industry has recently become interesting to study because of the fact that
microfinance institution (MFI) have some role in stimulating the economy through support for small and medium
enterprises (SMEs) and improve the welfare of society. MFI is described to overcome poverty through capital funding
for businesses organized by low-income communities. By MFI, the growth of micro/society business will be able to
survive and continue to grow.
In Indonesia, the MFI is usually found in the form of cooperative institution. Cooperative is an entity that
consists of a single person or a legal entity with the bases of cooperative activities based on the principles of
cooperation as well as economic movement based on the familyhood principle. Some types of MFIs in Indonesia are:
1. Saving and load cooperative
2. Savings and Loan Unit

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3. Community’s Funds and Credit Institution
4. Sharia Cooperative
5. Credit Cooperatives or Non Goverment Organizations
Baitul Maal wat-Tamwil (BMT) is a type of MFIs that implement the collection and distribution of funds on
the principles of Islam (sharia principle) basis. BMT legal entities are Sharia cooperative called Koperasi Jasa
Keuangan Syariah (KJKS). In this study, BMT hereinafter referred to Islamic microfinance institution (Islamic-MFI).
According to data from the financial services authority in Indonesia, called Otoritas Jasa Keuangan (OJK), Islamic-
MFI currently is estimated more than 500,000 cooperatives with total assets size in trillions. Until now, only about
200,000 cooperatives with total assets of more than 125 trillion recorded in the Department Of Cooperatives.
As commercial banks, Islamic-MFI has a goal of collecting and distributing funds from surplus
people/organization to the deficit people/organization. This business mechanism functions encourage Islamic-MFI to
give attention to risk management in its operational activities. Risk is the potential loss due to the occurrence of a
specific event (events). Risk management is a set of methodologies and procedures, which is used to identify,
measure, monitor, and controlling risk arising from the operations of the Bank (Bank Indonesia, 2009).
As has been mentioned earlier that the collection and distribution of funds from Islamic-MFI has
considerable exposure to risk, then Islamic-MFI should also do risk management practices for the purpose of securing
funds for its clients, in other word, securing the society’s fund. Bank Indonesia has required commercial banks and
Islamic business units to implement risk management practices at all operations. Types of risks that must be managed
include: Credit Risk, Market Risk, Liquidity Risk, Operational Risk, Legal Risk, Reputational Risk, Strategic Risk,
Compliance Risk, Yield Risks, and Investment Risk. While the implementation of risk management, some steps must
be taken: risk identification, risk measurement, risk monitoring and risk control.
This study aims to investigates risk management practices conducted by Islamic-MFI. Some of the questions
raised in this study are:
a. Have Islamic-MFIs adopted the practice of risk management (understanding risk management, risk
identification, risk assessment, risk monitoring, and credit risk analysis)?
b. What type of risk faced by Islamic-MFI?
LITERATURE REVIEW
MFI is an that run the bank's business activities as collecting and distributing funds from surplus entities to
the deficit entities, although to date the legal forms commonly used in Indonesia are cooperative. In 2013, the
Indonesian government has passed a regulation for microfinance institution to regulate the operasion of MFI
In Indonesia, since 2003, through regulation by Bank Indonesia (central bank), requires all commercial banks
to implement risk management in their business activities. This suggests that concerns about the practice of risk
management in the banking industry is very important. Some research on bank risk management practices have been
carried out, including studies conducted Al Tamimi and Al Mazrooei in 2007 were conducted in the United Arab
Emirates (UAE). This study compared the risk management practices conducted foreign banks and domestic banks.
The results show that there are significant differences in risk measurement and monitoring of national banks and
foreign banks. While the identification of risk, risk management practices, and credit risk analysis is not a significant
difference. In this study also indicated that foreign exchange risk, credit risk, and operational risk is the risk types
most frequently encountered.
Other research conducted by Syafique et al. (2013) who examine differences in the risk management
practices between Islamic financial institutions and conventional financial institutions in Pakistan. The results indicate
that there are six main types of risks faced by financial institutions in Pakistan namely credit risk, equity investment
risk, market risk, liquidity risk, rate of return risk; and operational risk. In the practice of risk management, there is no
difference between Islamic and conventional financial institutions in Pakistan.
Another study conducted by Tafri et al. (2011). This study compared the risk management practices of
Islamic banks and conventional banks in Malaysia. The results indicate that there are significant differences in the
results of measuring credit risk and operational Islamic banks and conventional banks in Malaysia. Other findings
indicate that the risk management and risk management systems in banks Islam inadequate.

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Khalid and Amjad (2012) measured the risk management practices of Islamic banks in Pakistan and found
that a good understanding of risk management in Islamic banking in Pakistan and all aspects of risk management has
positive relationship with the practice of risk management. Understanding and monitoring risk are found as two most
influential aspects of risk management practices in Pakistan. This study showed results consistent with the research of
Al Tamimi and Mazrooei (2007).
Husain and Al Ajmi (2012) in his study conducted in Bahrain, stated that the banker in Bahrain are aware of
the importance of risk management practices in reducing costs and improving performance. There are three main
types of risks faced by banks in Bahrain, namely credit risk, operational risk, and liquidity risk. The practice of risk
management in the banking sector in Bahrain is affected by variables such as the understanding of risk management,
risk identification, risk measurement, monitoring and risk management. This study also found no difference between
the bank's risk management practices of conventional and Islamic banks.
RESEARCH DESIGN
Researchers used a questionnaire to determine the risk management practices have been implemented by
Islamic-MFI. The original question developed by Al tamimi and Al Mazrooei (2007) consists of 43 questions and
divided into eight questions to determine:
a) 8 items for understanding of risk and risk management,
b) 5 items for risk identification
c) 7 items for risk assessment/measurement,
d) 6 items for risk monitoring
e) 9 items for risk management practices
f) 7 items for credit risk analysis performed
To determine the types of risks faced by Islamic-MFI, researchers gave an open answer to the
manager/middle staff consisting of 10 risks faced by Islamic-MFI, namely credit risk, operational risk, liquidity risk,
legal risk, debt risk, interest rate risk, reputation risk, price risk, strategic risk, and the competition risk. These types of
risk is the kind of risk that must be considered Bank Indonesia, as a rule and obligation for commercial banks and
Islamic business units of commercial banks.
The research design used in this study is an exploratory research. Exploratory research aims to understand
the characteristics of the phenomenon or problem under study because only few literatures that addresses the issue of
risk management practices and risk management methods conducted by Islamic-MFI.
The sample in this study was 30 Islamic-MFI in the form of BMT and KJKS that spread in Solo residency
(Karanganyar, Boyolali, Sukoharjo, Klaten and Surakarta). The sampling method used in this study was a
convenience slampling. This sampling method is choosen due to the limited information on the number of Islamic-
existing MFIs. In addition, the owner/manager of MFI usualy not transparent in providing information for researchers.
The data analysis employed in this research is descriptive statistics and univariate analysis. The method of
analysis used in this study using descriptive statistics and univariate analysis to provide information relating to the
extent to which risk management practices has been performed Islamic-MFIs and what risks faced by the Islamic-
MFIs.
RESULT AND DISCUSSION
Results of descriptive statistics in Table 1 shows that the respondents answers for Likert scale (1=very
disagreed, 7=very agreed) used to measure the agreement of statement for dimensions of risk management are over
the average value of 4 with an average span of 4.59 to 5.84. These mean that there is a tendency of respondents agreed
with the statement given. Islamic MFIs agree that they understand, able to identify, able to assess, and monitor risk
management.

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Table 1: Risk Management Practice
Description Mean Std.Dev Minimum Maximum
Dimension of Risk Management:
Understanding of Risk Management 5.84 0.88 3 7
Risk Identification 4.59 1.22 2 7
Risk Assessment and Analysis 4.81 1.07 2 6
Risk Monitoring 5.33 0.91 4 7
Risk Management Practice:
Risk Management Practice 5.44 1.01 3 7
Credit Analysis 5.55 1.31 1 7
Table 1 shows that for the dimensions of risk identification, which has the lowest average response of 4.59,
had the highest standard deviation of 1.22. This indicates that the ability to perform risk identification by the Islamic-
MFI lower than other risk management activities and there is a wide variation in the ability to identify risk between
Islamic-MFIs.
The opposite condition is indicated by the average value of the understanding dimensions of risk
management at the highest average of 5.84 with a standard deviation of 0.88. On average respondents were equally
likely to have a high understanding of risk management.
Table 1 also shows that the respondents agreement that they implement risk management practices is high
where the average of respondents' answers is 5.44 with a standard deviation of 1.01. The agreement to the statement
that Islamic-MFIs perform credit analysis showed on average higher than risk management at the average 5.55,
though with a wider standard deviation is 1.31. All respondent have implement risk management in spite of different
understanding and different emphasis of risk management activities.
Table 2: The Relationship of Risk Management Dimensions
and Risk Management Practice
Level of
Risk Management Practice
Understanding Identification Asssessment Monitoring
Low (mean=4.67) 5.25 4.40 3.75 4.58
Middle-Low (mean=5.39) 5.75 4.80 5.04 5.42
Middle-High (mean=5.61) 6.09 4.20 5.36 5.54
High (mean=6.08) 6.25 4.95 5.11 5.79
Univariate analysis is then performed to rank the level of risk management practices into four groups with
each group consist of 4 respondents from low to high. Through this ranking, the evaluation of the average response for
each dimension of the measurement is compared.
Table 2 shows that the average response for dimension of understanding increased from low to high risk
group practice management. Increasing understanding of risk management has increased the level of risk management
practices performed Islamic-MFI. The same relationship is also seen in the dimensions of assessment and monitoring.
On the dimension of risk identification, the average response rate is not consistently shown an increase.
These results indicate that the ability to understand, carry out assessment, and monitoring of risk
management are related to risk management practices in the observed sample. While the ability to identify risk
management showed no relationship with the risk management practice.

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Table 3: The Relationship of Risk Management Dimensions and Credit Analysis
Level of
Risk Management Practice
Understanding Identification Asssessment Monitoring
Low (mean=4.71) 5.25 4.10 3.68 4.67
Middle-Low (mean=5.11) 5.66 4.95 4.57 4.96
Middle-High (mean=5.68) 6.09 4.20 5.36 5.54
High (mean=6.71) 6.34 5.10 5.64 6.17
In Table 3, the same analysis was also carried out with the consent of the respondents rank the credit
analysis. Consistent with the answer on the relationship between risk management practices and dimensions of
understanding, assessing, and monitoring risk management, the increase in these dimensions also increase the credit
analysis performed. As for risk identification, analysis showed no relationship with credit.
Inconsistent results on the identification of risk indicates that there is still a shortage of Islamic-MFI staffs
skills in identifying the risks faced by their business. The inability to perform this activity may result in the
incapabiity to identify potential threats to their business.
Management of Islamic-MFIs need to improve the skills of their staff in risk identification periodically, so
that they do not dwell only on the risk that they understand it, but also the threat of potential risks they could not
identify. Given the vital role of MFIs in the community, especially for SMEs, it is government or policy makers that
should encourage the improvement of Islamic-MFIs’ ability and skills in risk identification.
Table 4: Perception of Risk Type Faced by Islamic-MFI
Risk Types Faced by Islamic-MFI No. I-MFI
Credit Risk 15
Operational Risk 10
Liquidity Risk 9
Legal Risk 1
Debt Risk 13
Interest Rate Risk 8
Reputation Risk 9
Price Risk 4
Strategic Risk 2
Competition Risk 2
Based on the results of the Islamic-MFI respondents about the type of risks they faced, average respondents
were able to identify that credit risk, debt risk, liquidity risk, reputation risk, and interest rate risk is the risk faced by
their businesses. Number of Islamic-MFI stated that they face credit risk, credit risk, liquidity risk, reputation risk,
interest rate risk, sequantially, are 15, 13, 9, 9, and 9 respondents. The other type of risks are less ignored. They are
price risk, strategy risk, competition risk and legal risk.
This condition is related to the ability of risk identification, where some risks not yet be considered to affect
the business of Islamic-MFIs. As rapid increase in the number of MFIs, price risk, strategic risk, and competition risk
can be more important that they can ruin their business conditions. In addition, when there are changes in govement
regulations, the impact of legal risk will increase.
Policy makers need to prepare these MFIs given their importance for community's economy, particularly in
support of SMEs who often use their services to finance the business. Moreover, in 2015 the regulatory changes and
the implementation of the ASEAN free trade area will encorage Islamic-MFI to make large adjustment of some
complience issue and competition strategy. Development through training and seminars can be done to boost the
importance of the understanding and capabilities of risk management. Guidance in the form of the legal rules and the
necessary operating standards are needed so that they are able to survice and continuously supporting the community.

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Coaching in providing an overview of the competitive landscape and regulatory changes necessary to keep them
competitive.
CONCLUSION
This study aimed to investigate whether the Islamic-MFIs have implemented risk management practices and
to identify what types of risks faced by BMT and KJKS. The conclusion of this study are as follows:
1. Average Islamic-MFI shows that they have understood, is able to measure and monitor risk management.
However, the ability to perform risk identification by the Islamic-MFIs are still weak compared to other risk
management activities.
2. The observed Islamic-MFIs have implemented risk management practices and credit analysis.
3. There are relationships between ability to understand, carry out assessment, and monitoring of risk
management and risk management practices in the observed sample, but not for the dimension of risk
identification.
4. The increase in the ability to understand, carry out assessment, and monitoring of risk management, also
increase the credit analysis performed, but not for the dimension of risk identification.
5. Risks type that perceived by Islamic-MFI indicate their view that credit risk, debt risk, liquidity risk,
reputation risk, and interest rate risk is the prominent risk faced by their businesses, but not for other risks,
such as price risk, strategic risk, competition risk, legal risk.
This study has implications both Islamic-MFI management and policy makers in order to further enhance the
ability of MFIs in conducting risk management, especially in support of SMEs in the society. As it is known that the
sustainability to face global competition and global crisis is depent on the economic fundamentals of the economy of
the society.
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