Systematic and Unsystematic Risk Determinants of Liquidity Risk

between Islamic and Conventional Banks

The principle objectives of managing the Risk, Assets & Liabilities of bank either conventional or
Islamic remain the same over the years. This research was made with the purpose to determine
the influence of internal and external factors on liquidity risk of both Islamic and conventional
banks. It also includes the data from 2000 to 2010 and the research concludes that Islamic
banks maintain higher liquidity as compared to conventional banks. Furthermore, the paper
also reveals liquidity risk of Islamic banks is shaped by 4 out of 14 bank specific factors and 1
macroeconomic factor whereas 5 out of 13 exert influence on conventional banks liquidity.

Islamic banks work in line with conventional banks but loans and interest based banking add to
the advantage of conventional banks. In order to meet the statutory liquidity requirements
Islamic Interbank money market was established in Malaysia in 1994. Liquidity risk can be
managed internally but it’s currently facing the problem excess liquidity which results in low
return on investment. Islamic banking heavily rely on trade based financing instead of
Murabaha, as equity based financing is considered as high risk therefore it takes away banks
from indulging into economic activities.

To bring uniformity in interpretation of Islamic Sharia International Islamic Financial Market is

established and last resort option remains associated with interest based instrument.

Islamic banks offer different instruments of long medium and short term and the maturity of
which varies pressure mounts when equity based financing requires long term & debt based
requires short term commitments. Islamic banks need to ensure to have fully reserved the
demand deposits in order to meet the liabilities anytime.

Irrespective of the nature of the bank’s capital formation is always considered essential. The
risks which the Islamic banks face in capital formation are of different nature. Qarza hasna
enacts as saving account whereas the other investments includes the business risk depends the
how successful the business will be. The risks faced by Islamic banking are then transferred to
equity based deposits. There are 2 significant fund providers current account and unrestricted
investment account holders. IAH operates under Mudarabah which enables the bank to share
the profit and loss as long as the banks provide the ROR; it enables the IAH to keep its deposit
with banks.
The nature of the Islamic banking financing is more typical as compared to conventional
banking as it offer trade based financing therefore the banks that are engaged in equity based
financing also faces the business cycles and its risk.

Islamic banking has changed the relationship between lender and borrower as it shares the
profit and loss with the borrower, profit is shared based on mutual or agreed ratio. Islamic
banks which operate under two window tier seems insolvency prove however practically
Mudarabah model still has mismatch risk of assets and liabilities.

The results of the paper reveals Islamic banks are comparatively more liquid than conventional
banks though the Islamic banks have limited last resort option in form of IMM but they are
sufficient enough to meet the liquidity requirements the mean of the liquidity was 46%
whereas the mean of conventional bank were 36%. It also concludes the Islamic banks are
lower credit riskier than their counterparts; mean of the credit risk of Islamic bank is 18% while
the mean of conventional banks are 23%. It could be due to greater exposure of conventional
banks to credit risk. The outcomes of result shows Islamic banks are more risky sector finance
than conventional banks the mean of Islamic banks was 60%, on the other hand the mean of
other banks were 53%. Islamic banks are slightly more risky sector of finance &b it could be due
to deferred payments contracts & Murabaha as its accounted 67% of total Islamic financing.
Mean of the loan loss provision was slightly greater of Islamic banks 10% than 9% of
conventional banks. Assets ratio mean of conventional banks was 96% > than 95% of Islamic
banks. Mean of funds required to meet the unexpected losses was higher of Islamic banks
which stood at 30% whereas the mean of conventional banks was only 7%. Conventional banks
are 4 times greater than Islamic banks in size & this advantage enables them to achieve
economies of scale the outcomes of this paper also shown mean of ROA of conventional banks
was 10.75% greater than 10.65% of Islamic banks. The results of the effective management of
asset utilization were better of Islamic banks as the mean of it was 89.37% and the mean of
conventional banks was 89.13%.

This paper attempt to determine macroeconomic factors which influence liquidity risk of banks.
The factors which were examined are GDP, CPI, Output gap, IIR and Money supply. Out of these
macroeconomic factors inflation was positively correlated with liquidity which means the
increase in inflation encourages the banks to maintain higher liquidity. Outcomes also shows
positive correlation between liquidity and ROA, albeit Islamic banks adopts the old conservative
approach of maintaining more liquid assets to depositors requirement and still able to generate
profits.