Mitigating asymmetric information to enhance MSME Islamic financial inclusion by Islamic banks in Indonesia

Purpose - This study aims to explore and analyse the credit risk assessment procedure conducted by the Indonesian Islamic banks to address the issue of asymmetric information among their micro-, small- and medium-sized enterprise (MSME) clients. This study also investigates the gaps in credit risk assessment procedures by comparing Islamic banks’ practices and presenting several recommendations to reinforce the credit risk evaluation procedures and eventually promote more inclusion of the MSME segment into the Islamic financial services. Design/methodology/approach - This paper adopts a qualitative method by implementing a multi-case study research strategy. The data were gathered primarily through an interview approach by incorporating purposive uncontrolled quota sampling. Findings - The result of this study implies that the Islamic banks in Indonesia have their own unique approaches and strategies in assessing the credit risk and have several similarities in performing their evaluation procedures for the MSME. Despite seemingly adequate approaches and measures taken by the Islamic banks to eliminate the asymmetric information problem, the study identifies several gaps that occur within the Islamic banks’ methods of credit risk assessment. Research limitations/implications - Since this study focuses on Indonesia and emphasises the two segments of Islamic banks, which consist of Islamic commercial and rural banks, in performing the MSME credit risk assessment; therefore, the findings of this study were limited around the observed Islamic banks within the MSME segment purview. Practical implications - By referring to the recommendations as proposed by this paper, four implications could be expected from adopting these respective recommendations, among others: more effective evaluation procedures for the MSME, provision of a clear path and more efficient approach to assess the MSME units, lower financing cost and increase the confidence of Islamic banking industry in disbursing more financing to the MSME sector. This mechanism will potentially improve Islamic financial inclusion for the MSME due to the greater access to financial services; hence, the sector could contribute even more to Indonesia’s growing economy. Originality/value - By incorporating a multi-case study among Indonesian Islamic banks pertaining to their methods in evaluating MSME customers, this study identifies several gaps affecting the effectiveness of MSME credit risk assessment. Furthermore, this study also presents a proposed framework to address these gaps accordingly by suggesting the salient strategies to minimise the issues of information asymmetry and enhance the MSME credit risk assessment procedure.