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Liquidity risk.in islamic vs conventional banks

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  • 1.
  • 2. “ Liquidity means the availability of liquid assets to a company.”
    • Unable to meet its short term obligations.
    • Arises from difficulties in obtaining cash at reasonable cost from borrowings or sale of assets.
    • Component of market risk
    • Can cause the failure of an institution even when it is technically solvent.
  • 3.
    • Liquidity risk consists of:
    • Assets liquidity risk.
    • Called market or product liquidity risk
    • Arises when transactions cannot be conducted at quoted market prices due to the size of the required trade relative to normal trading lots.
    • Funding liquidity risk.
    • Called as cash flow risk
    • Arises when institution cannot meet payment obligations.
  • 4.
    • Liquidity risk in bank result
    • Bank’s ability to match the maturity of asset and liability is impaired.
    • Such risk result from mismatch between maturities on two sides of the balance sheet
    • Creating either a surplus of cash that must be invested or shortage of cash that must be funded.
  • 5.
    • It arising from both source (Assets & liability side) and is critical for Islamic Banks.
    • Cannot borrow funds to meet liquidity requirement.
    • Shariah’ does not allow the sale of debt other than its face value.
    • Selling debt based asset is not an option to Islamic financial institutes.
    • Assets of Islamic Bank’s are not liquid as compared to the assets of Commercial Banks.
    • Slow development of financial instruments Islamic Bank’s are also not able to raise funds quickly from the markets
  • 6. To evaluate the liquidity risk management (L R M) through a comparative analysis between conventional and Islamic banks of Pakistan. Liquidity risk is the risk that a bank may be unable to meet its short term obligations. This research would be addition into existing body of knowledge.
  • 7.
    • Ali (2004)
    • Analyzes the source of liquidity risk in Islamic banks and identifies the risk in different mode of finance.
    • Can be controlled by predicting the timing of cash flows.
    • Increasing the collateral amount can also mitigate the liquidity risk.
    • Smooth operation of banking depends on the smooth operation of the system.
    • Microeconomic imbalances are another factor.
    • Contractual forms of Islamic banking create the liquidity risk.
  • 8.
    • Salman and Amanat (2008)
    • Analyze the comparison in profits of Islamic and conventional banks which is measured by ratio of return on equity.
    • It is an empirical study.
    • They provides the specific risk management procedures of Islamic banks.
    • Concluded that equity based business in Islamic bank face more risk than that of conventional banks.
    • Because Islamic banks are new born banks.
    • Conventional banks have longer history so the practices that they are using are adequate to mitigate risk.
  • 9.
    • AbdulMajid and AbdulRais (2003)
    • Liquidity management is the larger risk weather for the Islamic or conventional banks.
    • It is critical and complex issue.
    • Islamic banks relay on the commodity Murabaha for their short term investment and liquidity management.
    • Sukuk structure is also being introduced for this purpose.
    • Islamic bank can meet their liquidity obligations by smooth operation.
    • Emphasizes the close cooperation between the IFI and the central banks.
    • To make such instruments that is eligible for the Islamic banks reserve requirements.
    • Central banks should hold Sukuk as a part of their portfolio.
  • 10.
    • Moin
    • Analysis between Islamic banks and conventional banks.
    • Measured by different financial ratios.
    • Islamic banks are less profitable than conventional banks.
    • Islamic banks are stated only few years back so their economies of scale is quite low.
    • Conventional banks have an experience to handle risks and profits .
    • Risks cannot be detached with profits however Islamic banks can improve their liquidity management techniques by improving their practices to mitigate risk.
  • 11. Ho: Banks with Islamic Financing have on average High liquidity risk than bank without having Islamic financing facilities. H1: Banks with Islamic Financing have on average lower liquidity risk than bank without having Islamic financing facilities.
  • 12.
    • The nature of data is secondary.
    • The source of all the data is from the annual reports of past three years i.e. 2008 to 2010.
    • Financial data from these annual reports is used to calculate and to evaluate the liquidity risk management in conventional and Islamic banks of Pakistan.
  • 13.
    • Following ratios are calculated for this purpose:
    • Cash deposit ratio (CDR)
    • Current ratio (CA)
    • Current asset to total Assets ratio (CATA)
  • 14. Cash Deposit Ratio = Cash Deposit
  • 15. Current ratio = Current Asset Current liabilities
  • 16. CATA = Current Asset Total Asset
  • 17.
    • Comparative study.
    • Study employed two banks.
    • Analyze through the ratios.
    • Islamic bank has lower deposit ratio.
    • The Current ratio of Allied Banks shows increasing trend
    • Dubai Islamic bank which shows decreasing trend.
    • CATA ratio is lowers in Allied Banks as compared to Dubai Islamic bank.
  • 18.
    • Conventional banks have better techniques to mitigate the liquidity risk.
    • Islamic banks can hedge the liquidity risk.
    • They can mitigate it by:
    • Internal and external audit.
    • GAP analysis.
    • By applying new Shariah’ compliant techniques.
    • Liquidity management decisions.
  • 19.
    • Can take other financial institutions.
    • Can be analyzed through the experimental procedures.
    • Limitation of time and resources.
    • Study can also be enhanced through different variable.