Abstract
•Islamic banks tend to hold more liquid reserves and interbank assets than conventional banks.•Liquidity risk indicators of Islamic banks have been affected differently than those of conventional banks.•Capital acts as a buffer against risky liquidity creation.•The negative liquidity position of Islamic banks in money market must be covered by bank capital.•Islamic banks can use commodity murabaha in money market covered by bank capital and continue to create liquidity while remaining solvent.
This paper examines the liquidity risk of Islamic and conventional banks (referred to as IBs and CBs, respectively) by looking at the impact of bank-specific variables on three complementary liquidity risk measures in the Saudi banking system, in which both types of banks operate. Applying the least squares dummy variable corrected (LSDVC) approach over the period from the first quarter of 2008 to the second quarter of 2018, our analysis suggests that the liquidity risk indicators for IBs have been affected in a different way to those of CBs: (i) Using the financing-to-deposits indicator, larger IBs typically have on average a narrower funding gap than smaller ones. The largest CBs, meanwhile, have more vulnerable funding structures than the largest IBs. Islamic and CBs that are more oriented toward traditional intermediation activities have a wider funding gap. (ii) In terms of the interbank ratio indicator, IBs with stronger capital may need to rely more on interbank funding and may be more likely to be net borrowers than the less-capitalized IBs. CBs that can secure more net interest income tend to have better liquidity positions than IBs. (iii) In terms of the liquidity-ratio indicator, IBs with stronger capital tend to hold less liquid assets as a proportion of their short-term liabilities than smaller ones. Moreover, we show an opposing behavior for the two types of banks for capital ratio and ROA. If CBs are better capitalized and realizing more revenue on assets, they tend to have a greater liquidity ratio than IBs with the same characteristics.