Liquidity and liquidity risk management in islamic banks : an empirical analysis

Abstract

The major business of the banks is maturity transformation of funds through mobilization of deposits which are repayable on short notice demand and use the deposits to provide longer period financing or credit facilities to the borrowers. Inability of the banks to match depositors’ demand for withdrawal with realization of longer-term assets exposes banks to liquidity risk. Thus, liquidity management becomes a critical issue/area that calls for attention and prudential supervision by the banking regulators. Past and recent failure episodes of many conventional banks, various financial crises experienced by few Islamic banks in the recent past, and current global financial crisis are testimonies to the fact that liquidity risk (shortages) is a direct consequence of ineffective and inefficient liquidity management. In a nutshell, liquidity risk is a critical issue which is detrimental to the health of financial system and harmful to the real economy. Though, given the perception of the worldwide ongoing rapid growth of the Islamic financial industry, the assumption is that Islamic financial system enjoys surplus liquidity. Hence, it is not vulnerable to this problem. However, the recent failure and closure of some Islamic banks spurred by financial crisis is a sufficient proof that there is a need for sound financial stability and efficient liquidity management which requires urgent attention and redress in order to protect the reputation of the nascent Islamic banking industry. Therefore, this study through the participation of practitioners in some full fledged Islamic banks, subsidiaries and Islamic windows and experts in Islamic banking and finance intends to investigate the causes of the liquidity problems in Islamic Banks in spite of the claimed excess liquidity, patronage and continuous growth being enjoyed by Islamic financial institutions, and determine how effective and efficient liquidity management can be achieved. The study employed quantitative data analysis using statistical tools such as SPSS 16.0 and AMOS 16.0 and statistical techniques like Descriptive Statistic, Factor Analysis and Structural Equation Modeling (SEM). The findings revealed the impacts of regulation and supervision, Islamic financial instruments; Islamic corporate governance and Islamic financial ethics towards ensuring sound liquidity risk management in Islamic banks and also identified strategies for enhancing Islamic banking liquidity risk management. The Structural Equation Modeling produced a model fit for the Islamic banking liquidity risk management framework which confirmed the relationship between liquidity risk management and its hypothesized predictors.