Liquidity Risk Managment

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Interdisciplinary Journal of Research in Business

Vol. 1, Issue. 1, January 2011(pp.35-44)

Liquidity Risk Management: A comparative study between Conventional and Islamic Banks of Pakistan Muhammad Farhan Akhtar, Khizer Ali, Shama Sadaqat
Hailey College of Commerce, University of the Punjab, Lahore, Pakistan.

ABSTRACT The role of Bank is diversified into financial intermediaries, facilitator and supporter. Yet the banks place themselves as a trusted body for the depositors, business associates and investors. Liquidity risk may arise from these diverse operations, as they are fully liable to make available, liquidity when stipulated by the third party. Additional efforts are required by Islamic banks for scaling liquidity management due to their unique characteristics and conformity with sharia principles. The objective of this study is to look into the liquidity risk associated with the solvency of a financial institution, with a purpose to evaluate liquidity risk management (LRM) through a comparative analysis between conventional and Islamic banks of Pakistan. This paper investigates the significance of Size of the firm, Networking Capital, Return on Equity, Capital Adequacy and Return on Assets (ROA), with liquidity Risk Management in conventional and Islamic banks of Pakistan. The study is based on secondary data, that covers a period of four years, i.e. 2006-2009. The study found positive but insignificant relationship of size of the bank and net-working capital to net assets with liquidity risk in both models. In addition Capital adequacy ratio in conventional banks and return on assets in islamic banks is found to be positive and significant at 10% significance level. Keywords: Liquidity risk, Conventional Banks, Islamic Banks, Pakistan.

1. 0 INTRODUCTION The banking sector is considered to be an important source of financing for most businesses. Today the most familiar region of risk with conventional and Islamic banks is liquidity risk. Liquidity risk is the outcome from the disparity involving the maturities of the two sides of the balance sheet. This disparity either results in an excess of cash that wishes to be invested or result in a deficiency of cash that wishes to be funded. Also liquidity risk surfaces from complexities in acquiring cash at logical cost. As loans that are based on interest are forbidden in Islamic banks, cannot make use of such funds to congregate liquidity obligations in need. In addition the vending of debt is not permitted (Anas & Mounira, 2008). Extra liquidity with Islamic banks cannot be straightforwardly relocated to conventional banks as the Islamic banks do not recognize interest. Conversely the larger the quantity of Islamic banks and broad their functions, the better will be the capacity of assistance in this area. Banks are motivated by various reasons to hold certain amount of liquid balances. Liquidity refers to the ability of the bank to meet up deposit withdrawals, maturing loan request and liabilities without setback 1. Banks defends its customers aligned with troubles of liquidity by captivating in financial liabilities that can be drained on demand, on the added side of the balance sheet, offering dedicated lending services. The arrangement of balance sheets of banks usually illiquid loans are financed by extremely liquid deposits 2. Liquidity in financial markets has multiple connotations. Liquidity signifies the aptitude of a financial firm to keep up all the time a balance between the financial inflow and outflow over time (Vento & Ganga, 2009). Likewise in the preceding decade worldwide growth rates of 10% to 15% per annum has been experienced by Islamic banking. In addition with their presence in over 51 countries shows increasing pace of Islamic banking system moving into conventional financial system (Sole, 2007). 1

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