Debt financing and default risk in competitive housing market

Abstract

Credit score plays a vital role when Islamic banks decide whether to provide financing. Credit scoring systems are utilized by banks to determine if consumers are a good risk for financing requests. Data is analyzed from the financing application and the financing report evaluating items such as: bill-paying history, the number and ability of accounts opened, late payments, collection actions, outstanding debt and the age of the accounts. It reviews all applicants objectively by comparing the consumers' financing information to the financing performance of consumers with similar profiles. In smaller communities, shopkeepers, bankers, and others who extend financing often knew by word of mouth who paid their financing and who did not. As some Islamic banks became larger and as the number of their consumer financing applications grew, these Islamic banks needed to establish more systematic and efficient methods for evaluating which consumers were good credit risk. Credit scoring is one such technique. Most credit scoring systems are unique because they are based on an Islamic bank's individual experiences with consumers. To develop a system, an Islamic bank will select a random sample of its consumers and analyze it statistically to identify which characteristics of those consumers could be used to demonstrate creditworthiness. Then, again using statistical methods, an Islamic bank will weigh each of these factors based on how well each predicts who would be a good credit risk. As the Islamic bank is a trustee of public funds, it is incumbent upon it to utilize these funds in ways that protect the rights of the owners of these funds. Therefore, studies on risk underlying Islamic modes of finance are extremely important. They promote a sound understanding of various aspects of Islamic banking operations, an understanding that is needed by supervisory institutions. Thus, this paper will to combine the ideas from inter-temporal consumption theories under asymmetric information to provide a unified explanation of default risk in housing market.