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Literatures on Islamic economics and islamic banking reveal that profit and loss sharing become the most important financing in the financial system, but islamic banking practice is highly dependent on mark-up financing with murabaha financing. Islamic banks avoid financing for the results especially with mudharabah contract due to the high risk on this financing. Banking statistics shows that the composition of financing with mudharabah contract is low compared to murabahah financing. This is because Islamic banks avoid mudharabah financing due to its high moral hazard risk, although financing Mudharabah can drive the real sector economy. This study proves that moral hazard risk of mudharabah financing can be reduced by incentive compatible constraints as risk mitigation of islamic banks. The findings of this study indicate that the high moral hazard risk on mudharabah financing in Bank Nagari Syariah from 2011 to 2015 can be minimized by establishing several covenants at the beginning of the contract. Establishing the covenant at the beginning of the contract is an incentive compatible constraints. Incentive compatible constraints format was introduced by John R. Pressley and Session as an asymmetric risk mitigation of moral hazard information. The Bank Nagari Syariah mitigates moral hazard risk through supervision and monitoring. The data mining process uses structured interviews run by financing analysts and sharia risk management team of Bank Nagari Syariah. Documentation in the form of bank financial statements, implementation guidelines of sharia financing and sustainability report 2014. Qualitative data are obtained through interviews and documentation, while quantitative data are sourced from bank financial statements by doing financial ratio analysis. Descriptive qualitative is the technique for data analysis. The results of this study explain that Islamic banks can set some requirements at the beginning of the contract to avoid the occurrence of moral hazard risk on mudharabah financing. Incentive compatible constraints is effective to reduce moral hazard for corporate costumers.

Risk Mitigation of Moral Hazard on Mudharabah Financing (Case Study : An Islamic Bank)