Agency problem in microenterprise financing of Baitul Maal wa Tamwil in Indonesia

Abstract

Poverty is a major economic challenge, and small and medium enterprises (SMEs) play a crucial role in Indonesia's economy, highlighting the potential role of Islamic microfinance institutions (IMFIs) in alleviating poverty in Indonesia. However, IMFIs encounter obstacles, including agency problem, inadequate infrastructure, and unfavorable socioeconomic conditions. Baitul Maal wa Tamwil (BMT), an IMFI in Indonesia, offers unique features and a social development program to enhance its poverty alleviation impact. While there are many studies being conducted on BMT in Indonesia, studies on agency problem specifically related to Sharia-compliance towards achieving operational efficiency in BMT are still lacking and require a thorough comprehension. This study aimed to identify the nature of the agency problem faced by BMT in providing finance to microenterprises in Indonesia, investigate the reasons behind this problem, evaluate BMT's efforts to minimize it, and propose a strategy to overcome this issue in providing finance to microenterprises in Indonesia. This study uses qualitative methods involving 85 participants from active certified Sharia cooperatives, which were part of the oldest BMT established in each province, as well as experts from regulators and academics. Data was collected through interviews, observation, and document analysis. The data was then analyzed using NVivo Qualitative Data Analysis Software (QDAS), and the findings were interpreted. Qualitative reliability techniques were used to assess the reliability of results, with transcripts reviewed to prevent errors and code descriptions, and two independent experts in Islamic microfinance verified the topic's authenticity and obtained feedback. The study reveals agency problem in microenterprise financing at BMT, including adverse selection, ex-ante moral hazard, post-ante moral hazard, and untrustworthy behavior among management staff. The agency problem arises from human Resource (HR) and governance issues, member factors, and inaccurate financing analysis, exacerbated by business conditions that can lead to improper contract selection and BMT's financial stability. BMT addresses these issues through standardizing SOPs, approving staffing and financing SOPs, and regular evaluations. BMT enhances HR capacity through online or offline training, including Sharia finance, bookkeeping, training, and information system facilitation. Despite funding constraints and pandemic conditions, BMT officers conduct member coaching and mentoring activities. BMT is also implementing a strategy to enhance microenterprise financing, focusing on governance, HR capacity, and financial literacy. The plan includes regular staff visits, tightened supervision, recruitment strategies, coaching, mentoring, and training. Special programs and collaborations with universities, Sharia scholars, and policymakers are also being considered. The findings show that BMT's financing performance is negatively impacted by low Islamic financial literacy among staff and poor governance. These findings highlight agency problem in microenterprise financing in BMT, emphasizing the need for regulatory clarity, supervisory structure enhancement, and collaboration between BMT associations and institutions. The significance of research findings can be enhanced through consistent methodologies in different settings or varied methodologies within the same research environment.