Credit risk management practices and their determinants : an investigation of the Indonesian Islamic banks

Abstract

Credit risk is deemed to be the leading source of problems in banking institutions. This thesis aims to analyze the management of credit risk in the Indonesian Islamic banking industry, particularly to evaluate the practices of credit risk management of Islamic banks and to compare the factors differentiating credit risk management practices between Islamic banks and conventional banks. In addition, the study aims to determine the key factors affecting credit risk in Islamic banks for the period of 2004 to 2012 and to examine the relationship between credit risk and financing structure. The study applies both quantitative and qualitative methods to handle different aspects of the research objectives and to gather all relevant information on credit risk management and to construct the main output of the study. This study utilizes three statistical analyses and econometric models, which are a dynamic panel data analysis, Ordinary Least Square (OLS) regression analysis, logistic regression coupled with a questionnaire survey and a qualitative interview technique to evaluate empirical evidence regarding credit risk management practices of Islamic banks operating in Indonesia. The overall summary of results shows that while most of the results are in line with the expectations, others are not in line with the underlying theories, which are life-cycle theory of consumption and agency theory. The findings show that the key factors affecting credit risk in Indonesian Islamic banks are real GDP growth, financing growth, bank size, profitability, cost efficiency and ownership concentration. However, the results also indicate that three explanatory variables which include unemployment rate, bank’s capital and diversification do not support their respective hypotheses since the coefficients of these variables are in the opposite direction as expected by the theory. Furthermore, with regard to credit risk management practices (CRMP), the results show that there is a general understanding of CRMP throughout the Islamic banking system in Indonesia, and all the aspects of credit risk management have a positive relationship with CRMP. By providing the empirical evidence on the factors affecting credit risk in Indonesian Islamic banks, it is hoped that this study could enhance greater understanding of credit risk management framework. Furthermore, it is hoped that the findings could create awareness to the Islamic banks regarding factors affecting credit risk in Islamic banks so that they can properly manage credit risks. In addition, the finding from the study would be useful to the policymakers and regulators in making informed decisions and formulating policies that will indeed contribute to the bottom-line of the banks and indirectly help to prevent systemic risk.