Do Islamic rural banks consider Islamic morality in assessing credit applications?

Journal of Islamic Accounting and Business Research
Do Islamic rural banks consider Islamic morality in assessing credit applications?
Mahfud Sholihin, Ahmad Zaki, Aviandi Okta Maulana,
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Mahfud Sholihin, Ahmad Zaki, Aviandi Okta Maulana, "Do Islamic rural banks consider Islamic morality in assessing credit
applications?", Journal of Islamic Accounting and Business Research, https://doi.org/10.1108/JIABR-01-2018-0015
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1
Do Islamic rural banks consider Islamic morality in assessing credit
applications?
1. Introduction
One of the distinctive characteristics of Islamic finance is its emphasis on moral-laden
considerations. Hence, financial institutions claiming to be Islamic banks should also
implement Islamic morality when conducting business. Previous studies (e.g. Haniffa &
Hudaib, 2007; Maali, Casson, & Napier, 2006; Zaki, Sholihin, & Barokah, 2014) argue that
Islamic banks should position Islamic ethics as their ideal identity. Haniffa and Hudaib
(2007), for example, state that Islamic banks should show their Islamic ethical identity in
various ways: in their vision and mission statements; Board of Director (BOD) and top
management composition; product management; zakah, charity and benevolent loans
execution; engangement with employees, debtors, community; and Sharia Supervisory Board
(SSB) disclosure. Empirically, using samples of Islamic banks in Arabian Gulf region from
2002 to 2004, they have explored whether a discrepancy exists between the ideal and
communicated ethical identity of those Islamic banks. They found that only one Islamic bank
out of seven studied was above average, and the rest suffer from a disparity between the ideal
and communicated ethical identities. They suggest that future studies should investigate the
actual identity of Islamic Banks1
. To respond to their suggestion, the primary objective of this
present study is, therefore, to investigate whether Islamic Rural Banks (BPRS) implement
Islamic ethical identity when conducting business. In particular, this present study explores
whether BPRSs consider Islamic morality, i.e. Islamic teachings such as keeping promises to
customers, to suppliers, to neighbours, avoiding gharar (not clear contract), haram
(unpermissible), itstikar (hoarding), riba (interest) and riswah (bribe), in assessing credit
1
We define actual identity of Islamic Bank as whether Islamic Banks implement business strategy, values and
philosophy, and corporate culture in accordance with Islamic teachings. (For detailed discussion on actual,
communicated, ideal and desired identity, see Gray and Balmer (1998) and Balmer and Soenen (1999).

2
applications (financing decision) or only consider the standard criteria, i.e. the 5Cs
(Character, Capacity, Collateral, Capital, and Conditions).
This present study is important because, while the aforementioned studies have
advanced our understanding on the importance of moral issue of Islamic financial
institutions, the key question on whether Islamic rural banks in Indonesia consider Islamic
morality in credit analysis remain unanswered. We fill in this gap. This study will answer the
following research questions: 1) What factors do Islamic rural banks consider when making
credit application assessments? 2) How do Islamic rural banks consider Islamic morality
when conducting credit analysis? 3) How important are the moral issues that are considered
in credit application assessmenys by Islamic rural banks? In this study, we focus on
individual, not institutional, credit applications as the majority of the credit applications to
BPRS come from individual debtors.
This current study focuses on Islamic rural banks as it is one type of Islamic financial
institution that has an important role in Indonesian small and medium enterprises. Conducting
business directly with the Indonesian citizens which are predominantly Muslims, Islamic
rural banks increase their financing activity of around 28% yearly as they are operating in
almost every district within the country (Bank Indonesia, 2013). This study aims to contribute
to the literature on both Islamic finance and Islamic bank practices. Whilst many studies have
investigated credit decisions such as through the success of the organisational structure and
organisational policies in Grameen bank (see. Jain, 1996), the role of social network of credit
information (see. Okten and Osili, 2004), and the used of lending technology (see. Bartoli et
al., 2013), none of them observed Islamic rural banks as the investigation topic. On the other
hand, while many studies have examined micro finance and/or BPRS (e.g. Karim, Tarazi, &
Reille, 2008; Riwajanti, 2013; Seibel, 2008), none of them have looked at the credit decision
analysis. Additionally, this study will enrich finance literature by bridging the gap in the

3
research which is mostly dominated by the role of particular credit scoring such as the use of
subjective judgement of the 5Cs in credit analysis (see. Yu et al., 2015). Whilst previous
studies (e.g. Coffman, 2001) have discussed the credit scoring for small and medium
enterprises from a conventional perspective, this study, to the best of our knowledge, is the
first empirical study employing Islamic banks, particularly Islamic rural banks, as the object
of the study. From a practical perspective, this study will provide a clear picture of how
Islamic rural banks decide credit application approval.
The study finds that while Islamic rural banks conduct conventional credit analysis
using the 5Cs (Character, Capacity, Collateral, Capital, and Conditions), they also consider
Islamic morality in their credit decisions. They emphasise several indicators such as
reputation for keeping promises to customers, to suppliers, to neighbours; and Islamic
character (akhlaq) of the credit applicants. Overall, we conclude that Islamic rural banks
consider Islamic morality in their credit assessments.
The rest of the study is organized as follows. The next section provides a review of
the literature on Islamic banks and Islamic rural banks and their credit analysis tools. That
section is followed by an explanation of the research design covering types and sources of
data and data analysis techniques. Further, the findings and discussions will be divided into
two parts; exploratory findings on factors considered in Islamic rural banks credit analysis
and factor analysis for those factors. This study ends with conclusions and suggestions for
further study.
2. Indonesian Islamic Banking and Islamic Rural Banks
The Indonesian Islamic banking industry was initiated by the publication of Act No.7 of 1992
on banking and the establishment of Bank Muamalat aiming to implement a profit sharing
economy. However, the growth of Islamic banks in Indonesia is relatively stagnant with only
one Islamic bank and 78 Islamic rural banks (hereafter called BPRS) between 1992 to 1998

4
(Ika & Abdullah, 2011). Further, Act No.7 of 1992 was followed by Act No.10 of 1998
which describes the Islamic banking system more clearly. With the enactment of Act No.10
of 1998, banks in Indonesia could run a dual banking system, operating conventional banks
alongside Islamic banks as a business unit or stand-alone Islamic banks. The more specific
law about Islamic banking is Act No.21 of 2008. This Act provides a more precise legal basis
for Islamic banking and has triggered a more significant opportunity for people to get full
banking services in accordance with Islamic law. Now, as of January of 2017, there are 13
Islamic Banks, 21 Sharia Business Units, and 166 BPRS (Otoritas Jasa Keuangan, 2017).
BPRS is closely associated with micro-financing, a financing model that targets rural
and semi-urban areas concentrating on agricultural credit and micro-enterprise units. The
Asian Development Bank (2000) defines microfinance is “the provision of a broad range of
financial services such as deposits, loans payment services, money transfers, and insurance to
poor and low-income households and their microenterprises” (p.2). Microfinance services,
according to the Asian Development Bank (2000), are provided by three types of sources:
formal institutions, such as rural banks and cooperatives; semiformal institutions, such as
nongovernment organizations; and informal sources such as money lenders and shopkeepers.
According to Kaladhar (1997), micro-financing is a poverty alleviation paradigm for
rural and semi-urban areas emphasizing women borrowers. Furthermore, Kaladhar (1997)
states that the main principles of micro-financing are “borrower knows best” with a simple
procedure, i.e. the interest that does not burden borrowers, easy payment with a short period
of time, and the ease of getting a higher credit. Similarly, according to Otoritas Jasa
Keuangan (2015), microfinance institutions are developed for business development and
empowerment of micro business institution.
Mahaini (2014) states that Islamic microfinance institutions have rapid growth
offering a wide variety of financing products for Muslims who are unable to reach prosperity.

5
According to the regulation of Bank of Indonesia number 11/23/PBI/2009, BPRS are not
functionally different from the Islamic banking. Similar to Islamic banks, BPRS are allowed
to raise funds in the form of savings and deposits with mudharabah and wadiah, and
distribute them into various aqd (e.g. mudharabah, musyarakah, murabahah, and salam).
Furthermore, the credit provided by the BPRS, according to Muhammad (2005), can be
distinguished on the basis of purposes, working capital, and investments which can also be
divided into short-term credit (1-12 months), medium-term credit (1-5 years), and long-term
credit (> 5 years).
3. Credit analysis for BPRS
The Islamic Financial Services Board (2005) defines credit risk as the failure originating
from debtors’ failure to meet their obligations related to the credit agreement. In the
Indonesian context, risk management principles applied for Islamic banking are expected to
be in line with standard issued by the Islamic Financial Services Board (IFSB). Three
principles used in the calculation of capital adequacy ratios for Islamic banking are market
risk, operational risk, and credit risk. In particular, Act No.21 of 2008 article 34 explains that
Islamic banks shall apply good governance which includes transparency, accountability,
responsibility, professionalism and fairness in conducting their business. Furthermore, article
35 requires that in the course of their business, Islamic banks are required to apply the
precautionary analysis anticipating activities that do not harm the interests of the bank and the
customers who have entrusted their funds to the banks. Therefore, according to article 38 of
the Act, Islamic banks are required to apply risk management to understand their customers.
Van Gruening and Iqbal (2008) categorize the bank risks into four categories, i.e.
financial risk, operational risk, business risk, and event risk. In more detail, credit risk is
associated with the financial risk that induces risks to the client, product, and business
services in operational level.

6
In general, a widely used model for analysing credit risk is the 5Cs. The 5Cs also
require professional subjective judgements of the applications (Yu et al., 2015). Elements of
such credit analysis include (cf. Joseph, 2013, p.24):
• Character: This characteristic is widely scrutinized to assess the potential debtor’s
personal background, such matters as integrity and honesty. Perspectives on
personal background are considered to ensure the prospective borrowers will meet
their obligations on time. Examples of character assessment are the debtors’
personality rating to determine their honesty and good faith with regard to paying
off the loan, so the bank will not have any difficulty in the future.
• Capital: This factor is used to analyse prospective debtors’ ability and capacity to
carry out their everyday business. Banks should analyse the overall financial
position, so the banks can know the prospective borrowers’ ability to support the
proposed credit.
• Capacity: This factor is used to analyse the ability of prospective borrowers in
managing their business. This factor is about the expertise of debtors in the field
of business and managerial skills, so the banks are confident that the loan given
will be used well.
• Condition: This is a requirement in the credit agreement relating to the rights and
obligations of prospective borrowers. The condition can be seen from the results
of the agreement value, and prospective losses that will be borne by both parties.
• Collateral: The value of tangible assets provided by prospective borrowers that
can be used as a reference to the value or amount of the credit.

7
4. Method
This study employed several methods including focus group discussion (FGD), interviews,
document analysis, and questionnaire survey to collect the data. The FGD and interviews
were conducted because they could generate a more descriptive story and provide a narrative
to the topic being studied (see. Tracy, 2012, p.168). On the other hand, the questionnaire
survey was utilized in order to attempt to validate the findings. Accordingly, data gathered
from FGD and interviews were analysed through thematic analysis, while data gathered from
the questionnaire were analysed using descriptive analyses as the study is of the exploratory
type.
Before collecting the data, we conducted an FGD with experts to develop instuments.
The experts were the director of BPRS Harta Insan Karimah (a major national BPRS with its
headquarters in Jakarta, the capital city of Indonesia), a lending manager of a national Islamic
bank focusing on microfinance, and a team from the Islamic Bank Directorate of Financial
Services Authority of Indonesia.
For the FGD, interviews, and document anaysis, this study focused on BPRS in
Yogyakarta, a special province in Indonesia. In terms of its uniqueness, this province was
valuable to this study as it has numerous BPRS with different characteristics. For the
purposes of the FGD, we invited 11 BPRS in Yogyakarta. Among the 11, five BPRS were
available for further interviews and provided documents for detailed analysis. They were:
BPRS Bangun Drajat Warga (BDW), BPRS Mitra Cahaya Indonesia (MCI), BPRS Forum
Masyarakat Ekonomi Syariah (Formes), BPRS Barokah Dana Sejahtera (BDS), and BPRS
Dana Hidayatullah (DH). For the survey, we selected samples based on the recommendation
of the Islamic Bank Directorate of Financial Services Authority of Indonesia considering
various sizes, locations, and the ownership of the BPRS.

8
The FGD was led by a moderator, who was one of the researchers. In particular, the
moderator offered questions related to credit assessment. The moderator’s role was starting
and stimulating the discussion. The FGD was also attended by representatives of the BPRS
compartment in the Indonesia Islamic Banks Association. Following Bader dan Rossi (2002),
we divided the questions in the FGD into three sections: engagement questions, exploration
questions, and exit questions.
As previously mentioned, this study also employed in-depth interviews to provide
more in-depth insights into the topics. Legard et al. (2003) state that in-depth interviews or
unstructured interviews are the primary models for qualitative research data collection.
Burgess (1982) Lofland and Lofland (2006) describe this method as being a type of
conversation with purposes.
In detail, the questions offered during the in-depth interviews focused on:
a. Are there particular criteria to understand the risk of prospective borrowers?
b. What are other factors, out of regulated by policymakers, in assessing prospective
borrowers’ risk?
c. What are the factors derived from Islamic principles that are considered in
assessing the risk of prospective borrowers?
To support the analysis, this study also conducted analysis of the following
documents:
1. Standard operating procedure documents of the BPRS, particularly documents
related to credit risk;
2. BPRS organization structure;
3. Job descriptions of various units in BPRS.
For the suvey, the questionnaire used in this study consists of four parts. The first part
was about the respondents’ demography. The second part asked about the importance of

9
existing credit assessment tools (5Cs) in credit analysis using a five-likert scale, where one is
unimportant while five is very important. In the third part, respondents were required to rank
factors considered in credit assessments, i..e the 5Cs. This method was employed to confirm
the consistency of respondents’ answers with the second part of the questionnaire. The
highest priority was ranked as one. The fourth part requested details of factors identified. This
part consisted of 50 items and respondents were required to rate each item by circling the
score, one indicates extraordinarily unimportant or very rarely used, while five indicates
extremely important or very commonly used (See Appendix 1).
Additionally, the questionnaire also provided an open question type which asked the
respondents’ opinion on the five items that they think are very important and that should be
considered in assessing the credit risk of a prospective borrower and the way to measure or
detect the risk. In general, over 60% of respondents were account officers, and the rest were
credit decision makers. In terms of working period in Islamic rural banks, most of the
respondents had more than one year of experience. Also, most of the respondents had an
educational background in business.
Referring to data analysis techniques commonly used in qualitative research, data
gathered from FGD, document analysis, and interview were analysed through thematic
analysis. On the other hand, data gathered from the questionnaire were analysed using
descriptive analyses as the study is of an exploratory type.
Interview data were analysed through thematic analysis as suggested by Howitt and
Cramer (2014) in gaining critical topics for developing the framework. According to Howitt
and Cramer (2014), a thematic analysis is an analysis of textual material that reveals a
significant theme within it. Similarly, Braun and Clarke (2006) defined thematic analysis as a
method for identifying, analysing and reporting patterns (themes) within data and it assists in
organizing and describing a data set in rich detail. The stages of thematic analysis utilized on

10
this study refer to the thematic analysis steps recommended by Braun and Clarke (2006)
which cover textual material transcription, analytical process, and themes and sub-themes
identification.
Descriptive analyses were utilized aiming to validate the results of the qualitative
analyses.
4. Factors considered in BPRS credit assessments
Analysis of the data obtained shows that most BPRS that are the objects of this study use the
5Cs (character, capacity, collateral, capital, and conditions) model as the main tool for
assessing financing risk. In general, the FGD particiants agree that the 5Cs is an important
assessment tool in credit analysis. Related to the character factor, for example, a good debtor
is the one who will pay the instalments on time so that the financing losses can be minimized.
In particular, a director illustrates that:
"The prospective borrowers cannot be drunks, gamblers, thieves or fraudsters.
In short, the prospective borrower must have a good reputation”
Moreover, the interviews conducted with the BPRS managers support these findings
and they consider that the use of the 5Cs in credit risk assessment is an essential tool as they
said that the five principles are applied in everyday business practices. However, one of the
BPRS managers stated that even though they consider all of the 5C principles to be
important, in practice, only three of the five principles are implemented, namely character,
capacity and collateral.
“In terms of risk assessment, we are applying 5C .... However, according to our
experience in the field, we only use three main characteristics namely character,
capacity, and collateral”

11
Interestingly, although the 5Cs are considered to be the main model of credit risk
assessment used by BPRS, one criterion, which is character, is the most important factor as
described below:
“In general, we use the 5C approach .... However, in our bank, we stressed one
particular criterion, namely personal character”
The next part describes more detailed analysis of the findings for each element of the
5Cs. In addition to the 5Cs, the data reveal two other important factors considered in credit
assessment, namely community and sharia aspects.
Character
Character is an important 5C element considered by BPRS in analysing financing
risk. Assessment of the character or personality of the prospective borrower is conducted to
estimate the likelihood that a borrower can meet their obligations. One participant in the FGD
said that this factor is related to the integrity of prospective customers (borrowers) and their
business groups. As the trust (funds) will be given to the borrowers, they aruge that the
applicants should be genuinely trustworthy and have good faith with regard to repaying the
loan.
Another participant stressed that the financing products offered should be used for
productive and not consumptive purposes. To understand whether the funds are used for
productive purposes, a BPRS conducts assessment using two main activities: surveys and
interviews. The main goal is to know the character and ability of prospective customers. The
process is conducted by way of some visits to the neighbourhoods of prospective customers
and the completion of the form provided.
Furthermore, another participant stated that a moral assessment of prospective
borrowers is extremly important. One participants states, “For us, the morality of the
potential borrower is the most imortant thing and may rule out other criteria”. Additionally,

12
the type of business should be understood before a BPRS approves the credit application.
Among the sources used to assess their moral are the testimonies of suppliers, customers,
competitors, local communities, and local banks regarding their experiences with the credit
applicant. “We often asked the applicant’s previous suppliers, customers, and the local
community where the applicant lives, and even their business competitors and previous banks
they dealt with,” said one of the participants. Similarly, another paticipant said that the third
party opinions, previous financing history, their worship habits, responsibilities to their
families, relationships with neighbours, their patience, openness with BPRS, and openness to
their families, can also be used to make an assessment of an applicant’s character.
In addition, another FGD participant also used information from other banks,
including a formal request to the Indonesian central bank (Bank of Indonesia) to obtain
information about prospective borrowers, either their profiles and companies or businesses
they own. The document analysis used in this study also provided information related to
procedures developed by BPRS for judging the character of prospective borrowers. One of
them, for example, specified that the debtor must exhibit honesty, sincerity, promise
fulfillment, health, and willingness to repay his or her debts.
These findings are in line with the interview results. Character, according to a
majority of respondents, has a major role in the financing risk assessment process. The
evaluation of characters can determine the extent to which a person may be responsible for
the mandate given to him in terms of the financing agreement. Interviews also revealed that
the character assessment could be based on a borrower’s track record about the work
environment, fulfillment of the obligations in business activities, and relationships with
suppliers. In particular, analysis of this indicator can be done through information clearing
from the BPRS association, or associations of commercial banks.

13
Capacity
In term of business capacity, a business feasibility analysis is performed as one of the BPRS
financing risk assessments. This criterion indicates a management’s capacity to generate cash
flow and to ensure its ability to realise a cash flow projection into real cash sufficient to pay
its liabilities to the bank. The FGD revealed that cash flow projection analysis should be
conducted to ensure it is reasonable and reachable. The FGD also revealed that prospective
borrowers are required to draw up financing proposals which will then be presented to the
financing committee. An important thing highlighted in this criteria assessment is the history
of the business to be financed, which includes business age and business experience.
One participant also said that capacity could be deconstructed into managerial
capabilities and financial capabilities. Both of these support each other because financial
capacity is the result of company’s managerial capabilities. This capacity is important to
predict the size of a debtors’ future income.
Collateral
The collateral criterion aims to identify and assess the extent to which the risk of non-
fulfilment of financial obligations to the BPRS can be covered by the value of collateral
granted by prospective customers. Assessment of this factor can be done through analysing
the related collateral and other information that can support the value of collateral granted.
One of FGD participants noted that, in practice, there are several things one needs to aware of
with regard to financing guarantees. For example, a prospective customer who does not allow
BPRS staff to check the location of collateral, prospective borrowers who are unknown in the
environment around the business location, and the prospective borrowers who do not allow
the examination of the collateral.
Data obtained from document analysis revealed several policies applied by BPRS in
evaluating the value of the collateral. Among them is a procedure to assess the types or kinds

14
of goods, their value, location, and proof of ownership or legal status of the collateral.
Interview data tended to show similar findings. Collateral is perceived as the ultimate source
of repayment of agreed financing in case the borrower cannot pay the debt. Thus, the legal
aspects and the marketability of the collateral is a crucial consideration. The marketing
department of BPRS, according to respondents, should understand the type of collateral
pledged to the bank. To ensure this, they use at least six indicators which must be considered
in assessing this criterion. The considerations include the type of collateral, the name of the
owner, owner's consent, year of manufacture, collateral conditions, and the value of the
collateral.
The FGD participants agreed that collateral is primarily intended to protect the banks
against problems with the prospective loan. Thus, under normal conditions, when the analysis
has been done, and the customer has been recognized as being eligible for a financing
contract, the collateral is not more than a precaution.
Capital
Capital is another 5Cs component mentioned in the FGD as one of the aspects assessed by
BPRS in analysing financing risk. This factor comprehends the commitment of prospective
borrowers to their proposed business. The capital analysis also aims to determine the
company's ability to bear the necessary burden and the ability to bear the risk that may arise
for the company. More specifically, according to the FGD participants, large capital or a low
leverage ratios indicate the prospective borrower’s strong commitment. In practice, BPRS
also evaluate a company's retained earnings to assess whether the net income is accumulated
or distributed as dividends.
In the document analysis, it was found that BPRS assess the capabilities of
prospective clients to run and maintain business continuity through capital assessment. This

15
is done to determine the status of capital and sources of funds and their use. Data from this
assessment will then be used in determining the eligibility of prospective borrowers.
Condition
Business condition analysis is performed to assess the socio-economic situation of
prospective borrowers that may affect the repayment to BPRS. According to the FGD
participants, an economic condition assessment will affect the business activities of the
prospective customers. Furthermore, the FGD revealed that condition assessment of the
prospects of the business is an important factor to minimize the possibility of problems with
the debt repayment. This factor can be evaluated by assessing prospective borrowers’ ability
to overcome or anticipate problems in the business so that the business will keep operating
and grow. In more detail, this can be done by conducting direct visits to the prospective
customers to see their business conditions and the culture of the company.
Community
In the interview process, prospective borrowers’ involvement in certain communities was
also expressed as being another factor often assessed by BPRS. Among the indicators
considered by the BPRS in assessing this factor are the proximity of the prospective customer
to community leaders and the guarantees from certain figures. A BPRS bank affiliated with
Muhammadiyah, for example, will consider prospective borrowers with similar affiliation by
checking the data at the nearest branch office. Also, the presence of other debtors with the
same BPRS and the distance between debtors’ home and BPRS are also perceived as
reducing the risk of financing.
Sharia aspect
Data analysis also shows that the sharia compliance of a credit applicant is highly taken into
account by BPRS. The financing provided should not be used in a way contrary to the values
of the Qur'an and Sunnah. More specifically, the sharia assessment evaluates the agreement

16
of a prospective customer with the principles of Islam, both in terms of the production of
goods and operational systems, and in terms of avoiding the business having negative impacts
on the environment and society. Regarding products, businesses should be free from
gambling, gharar (not clear contracts), haram (the essence and way to get or produce it),
itstikar (hoarding), riba (interest) and riswah (bribe). One participant stated that the
assessment of this aspect is the job of the Sharia Supervisory Board (SSB). SSB will decide
whether the product of prospective borrowers follows the concept of Sharia.
This research also found that the important roles that should be played by BPRS are
1) to educate the poor 2) to resolve social problems 3) to conduct Islamic da’wah. The first
reason was stated by the Director of a BPRS as “the operational function of BPRS is to
educate the non-bankable society so it becomes bankable society”. This statement showed
that the existence of Islamic rural banks is to help the poor to access sources of finance.
Although poor people are non-bankable, with the assistance of BPRS, they can generate more
income and increase their status as capable individuals. Interestingly, BPRS also functions to
control someone who is already down so that they can recover. BPRS also functions as a
da’wah institution that can help to preserve the community.
5. Descriptive statistics analysis
The survey conducted in this study also supports the findings presented in the previous
section. Most of the respondents revealed that character is the most important aspect in the
financing analysis followed by the company's ability to generate cash flow (capacity) with an
average score of 4.89 and 4.74 respectively, on a scale of five. Furthermore, respondents also
gave the highest ranking to the character of candidates followed by the capacity of the
prospective debtors’. Collateral is rated and ranked equally in third place in BPRS financing
analysis. In the final sequence, the commitment of prospective customers through their

17
circumstances in terms of capital and their economic condition as a whole are in the fourth
and fifth. Table 1 summarizes the rating and ranking of the the 5Cs model.
INSERT TABLE 1 ABOUT HERE
Furthermore, the existence of sharia and community aspects revealed in the previous
findings is also consistent with the results of the survey. The results of factor analysis reveal
that the 50 items are grouped into 7 components with eigenvalues greater than 1 (See table 2).
We then name those components as Character, Capacity, Collateral, Capital, Conditions,
Sharia and Community. Additionally, when the respondents were asked in the open question
survey about other criteria that should also be considered in the financing risk analysis of the
survey, more than half of them stated that sharia and community aspects largely determine
the financing decision.
The results of the descriptive statistics for the 50 items of questionnaire are presented
in table 3. The table shows the highest rating, i.e. the most important, is the applicant’s moral
(akhlak) with a score of 4.68. Join in the second with a score of 4.61 are applicant’s business
history, applicants’s ability to manage the business, and the value of collateral in case of bad
debt. The lowest score, i.e. the least important, is customer sex with a score of 2.75.

18
6. Discussions and Conclusion
This study aims to investigate how moral issues are considered in Islamic rural banks
credit application analysis. To examine what factors are to be considered, this study applies a
mixed approach (qualitative and quantitative), using focus group discussions, analysis of
documents, interviews, and survey methods.
The findings of this study have shown some essential aspects that are considered in
the financing analysis of BPRS. The results also reveal that the managers of the BPRS have
very similar perceptions of the importance of the 5Cs. As revealed in the findings, all BPRS
concede that they are applying this model with a different level of significance. Most BPRS
only focus on some key aspects that are considered more important than others.
Additionally, this study finds there are various facors considered by Islamic rural
banks when processing a credit application assessment. Out of them, nine items are related to
moral aspects (relationship with society; reputation for keeping promises to customers;
reputation for keeping promises to suppliers; for keeping promises to neighbours; Islamic
moral [akhlak]; the community’s perception of the applicant; the applicant’s guarantor;
relationship with local leaders; and participation in the community). This result reveals that
Islamic rural banks consider moral to be part of their assessment of a credit application. The
importance of morality as an aspect of credit application assessment is further emphasized
with the notion that failure to meet the criteria in terms of moral factors will automatically
result in the application being denied, regardless of other factors being fully met.
The survey conducted in this study also supports the findings of the FGD, document
analysis, and interviews. As described in the research findings, most respondents reveal that
character is the most important aspect of the credit analysis followed by the company's ability
to generate cash flow (capacity). Furthermore, respondents also gave the highest ranking to
the character of the applicant followed by the capacity of the company receiving the loan.

19
The community factor that appears in this study has been applied by Grameen Bank in
Bangladesh using a model of the group containing 5 to 15 women (Khandker, 2005).
According to Zeller (1998) and Yaron (1994), loans with a group approach is more effective
in terms of credit repayment, because of the high level of collective responsibility for
business success. In the group approach, control of the business and credit utilization is done
collectively and reciprocally (peer monitoring) as part of an ongoing monitoring system.
Each member of the group feels similar responsibility for the success as do the other
members. When one member experiences a business failure, other members are obliged to
bear the obligation to return the loan. Furthermore, Kono and Takahashi (2010) in Ibtissem
and Bouri (2013) say that one way to mitigate the risks of financing can also be to use a
"group lending" approach or scheme.
The study also reveals existence of sharia aspect. The importance of sharia criteria
cannot be separated from the main characteristics of BPRS bound to the need for compliance
with the principles in Islamic law. Financing types of business that are forbidden, for
example, would not be allowed as the BPRS will be in a position of shohibul maal on
mudharabah. In this context, BPRS on the one hand, are parties who own the business.
Additionally, in relation to the sharia factor, the study found that the financing provided must
not be in conflict with the values of Islam. More specifically. the sharia factor is the
assessment of conformity with the principles of Islam for a prospective customer, of the
production of goods/merchandise, operating systems, as well as its impacts on the
environment and society. Furthermore, social relationships with the client community, the
guarantor(s), prospective debtors’ closeness with community leaders, and the involvement of
prospective debtors in certain communities are also considered important factors in the
community criteria.

20
The results of this study are in line with the four principles required by the Islamic
Financial Services Board (IFSB) regarding credit risk assessments made by Islamic financial
institutions. These four principles require the existence of a strategy, due diligence review,
appropriate method to measure and report credit risk, and the concept of credit risk mitigation
that conform to sharia principles. In particular, the emergence of the related moral criteria
emphasises how the mitigation concept which is widely used in a credit process is in line with
the purpose of Islamic rural banks.
Like other research, this study also has some limitations. Although FGD and
interviews data collection techniques are excellent in qualitative research, this study is limited
to BPRS in Yogyakarta. Conducting research with a more diverse context might provide
richer insights. Furthermore, the survey conducted in this study was limited to 28
respondents. To obtain more reliable results, testing the indicators with a larger number of
respondents is also highly recommended. However, this study is one of the early pieces of
research that can be used as a foothold in developing more comprehensive assessment models
suited for BPRS financing application analysis.

21
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23
Appendix 1. Items of the survey
1. Applicant's life history
2. Applicant's family history
3. Social relations of applicant with the community
4. Legality of applicant's business
5. History of applicant relationship with banks
6. Applicant reputation in keeping promises to supplier
7. Applicant reputation in keeping promises to applicants
8. Applicant reputation in keeping promises to neighbours
9. Applicant's morals
10. Applicant’s integrity
11. Applicant education background (business. nonbusiness)
12. Public view of applicant behavior
13. Applicant's business history
14. Applicant’s persistence
15. History of applicant's business performance
16. Applicant expertise in managing the business
17. Applicant's skill in conducting legal engagement
18. Applicant's ability to manage the business
19. Applicant's home status (rent. own property)
20. Marital status of the applicant
21. Applicant’s age
22. Applicant's sex
23. Applicant's highest education level
24. Number of dependents of the applicant
25. Periods of applicants in managing the business
26. Applicant revenue
27. Total liabilities of applicants
28. The amount of credit proposed
29. The suitability of the collateral value with amount of credit proposed
30. The amount of depreciation of the collateral
31. Easiness of selling the collateral
32. Easiness of monitoring the collateral
33. Location of the collateral
34. The value of the collateral in case of bad debt

24
35. Liquidity of applicant's business
36. Solvability of applicant's business
37. Profitability of applicant's business
38. Applicant's commitment to the business continuity
39. The amount of applicant's own business capital
40. Market share of the applicant's business
41. National political condition
42. National economic condition
43. Local social culture
44. Type of applicant’s business
45. Prospect of applicant’s business
46. Distance of applicant's house with the BPRS
47. The existence of other applicants to the BPRS in the area of origin of the applicant
48. The presence of people who guarantee applicants
49. The closeness of applicants with community leaders
50. Applicant involvement in a particular community

1
Table 1 Average score of the 5Cs rating and ranking
No. Factor Rating Ranking
Min Max Mean
(SD)
1 Character
4 5 4.89
(0.32)
1
2 Capacity
4 5 4.74
(0.46)
2
3 Collateral
3 5 4.63
(0.56)
3
4 Capital
3 5 4.41
(0.57)
4
5 Condition
3 5 4.30
(0.67)
5
Table 2 Total variance explained
Component
Initial Eigenvalues
Extraction Sums of Squared
Loadings
Total
% of
Variance
Cumulative
%
Total
% of
Variance
Cumulative
%
1 15.641 31.282 31.282 15.641 31.282 31.282
2 10.691 21.382 52.664 10.691 21.382 52.664
3 7.423 14.847 67.510 7.423 14.847 67.510
4 5.036 10.072 77.582 5.036 10.072 77.582
5 4.376 8.751 86.333 4.376 8.751 86.333
6 4.058 8.116 94.449 4.058 8.116 94.449
7 2.775 5.551 100.000 2.775 5.551 100.000
Extraction Method: Principal Component Analysis.
Table 3. The results of descriptive statstics of the 50 items
Items Min Max Mean Standard
Deviation
Applicant's life history 2 5 4.25 0.70
Applicant's family history 2 5 3.86 0.76
Social relations of applicant with the community 3 5 4.29 0.53
Legality of applicant's business 3 5 4.36 0.68
History of applicant relationship with banks 3 5 4.50 0.58
Applicant reputation in keeping promises to
supplier
3 5 4.32 0.61
applicants
3 5 4.33 0.62
neighbours
2 5 4.11 0.79
Applicant's morals 4 5 4.68 0.48
Applicant’s integrity 3 5 4.39 0.63

2
Applicant education background (business.
nonbusiness)
2 5 3.14 0.52
Public view of applicant behavior 3 5 4.07 0.47
Applicant's business history 4 5 4.61 0.50
Applicant’s persistence 3 5 4.18 0.61
History of applicant's business performance 3 5 4.00 0.54
Applicant expertise in managing the business 3 5 4.38 0.65
Applicant's skill in conducting legal engagement 2 5 3.61 0.74
Applicant's ability to manage the business 3 5 4.61 0.57
Applicant's home status (rent. own property) 2 5 3.89 0.69
Marital status of the applicant 1 5 3.57 0.96
Applicant’s age 2 5 3.61 0.63
Applicant's sex 1 5 2.75 0.89
Applicant's highest education level 1 5 2.79 0.79
Number of dependents of the applicant 2 5 3.57 0.63
Periods of applicants in managing the business 3 5 4.14 0.59
Applicant revenue 3 5 4.57 0.57
Total liabilities of applicants 4 5 4.50 0.51
The amount of credit proposed 3 5 4.29 0.60
The suitability of the collateral value with amount
of credit proposed
4 5 4.53 0.51
The amount of depreciation of the collateral 3 5 4.11 0.69
Easiness of selling the collateral 3 5 4.43 0.69
Easiness of monitoring the collateral 3 5 4.14 0.71
Location of the collateral 3 5 4.43 0.63
The value of the collateral in case of bad debt 4 5 4.61 0.50
Liquidity of applicant's business 3 5 4.54 0.64
Solvability of applicant's business 3 5 4.27 0.79
Profitability of applicant's business 3 5 4.27 0.65
Applicant's commitment to the business
continuity
1 5 4.25 0.93
The amount of applicant's own business capital 3 5 3.93 0.66
Market share of the applicant's business 3 5 4.11 0.69
National political condition 1 5 3.39 0.83
National economic condition 1 5 3.64 0.78
Local social culture 1 5 3.39 0.79
Type of applicant’s business 3 5 4.07 0.60
Prospect of applicant’s business 3 5 4.54 0.58
Distance of applicant's house with the BPRS 1 5 3.00 0.82
The existence of other applicants to the BPRS in
the area of origin of the applicant
1 5 3.36 0.73
The presence of people who guarantee applicants 2 5 3.43 0.63
The closeness of applicants with community
leaders
1 5 3.11 1.03
Applicant involvement in a particular community 1 5 3.32 0.90

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