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Liquidity risk.in islamic vs conventional banks

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Liquidity risk.in islamic vs conventional banks

  1. 1.
  2. 2. “ Liquidity means the availability of liquid assets to a company.” <ul><li>Unable to meet its short term obligations. </li></ul><ul><li>Arises from difficulties in obtaining cash at reasonable cost from borrowings or sale of assets. </li></ul><ul><li>Component of market risk </li></ul><ul><li>Can cause the failure of an institution even when it is technically solvent. </li></ul>
  3. 3. <ul><li>Liquidity risk consists of: </li></ul><ul><li>Assets liquidity risk. </li></ul><ul><li>Called market or product liquidity risk </li></ul><ul><li>Arises when transactions cannot be conducted at quoted market prices due to the size of the required trade relative to normal trading lots. </li></ul><ul><li>Funding liquidity risk. </li></ul><ul><li>Called as cash flow risk </li></ul><ul><li>Arises when institution cannot meet payment obligations. </li></ul>
  4. 4. <ul><li>Liquidity risk in bank result </li></ul><ul><li>Bank’s ability to match the maturity of asset and liability is impaired. </li></ul><ul><li>Such risk result from mismatch between maturities on two sides of the balance sheet </li></ul><ul><li>Creating either a surplus of cash that must be invested or shortage of cash that must be funded. </li></ul>
  5. 5. <ul><li>It arising from both source (Assets & liability side) and is critical for Islamic Banks. </li></ul><ul><li>Cannot borrow funds to meet liquidity requirement. </li></ul><ul><li>Shariah’ does not allow the sale of debt other than its face value. </li></ul><ul><li>Selling debt based asset is not an option to Islamic financial institutes. </li></ul><ul><li>Assets of Islamic Bank’s are not liquid as compared to the assets of Commercial Banks. </li></ul><ul><li>Slow development of financial instruments Islamic Bank’s are also not able to raise funds quickly from the markets </li></ul>
  6. 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. 7. <ul><li>Ali (2004) </li></ul><ul><li>Analyzes the source of liquidity risk in Islamic banks and identifies the risk in different mode of finance. </li></ul><ul><li>Can be controlled by predicting the timing of cash flows. </li></ul><ul><li>Increasing the collateral amount can also mitigate the liquidity risk. </li></ul><ul><li>Smooth operation of banking depends on the smooth operation of the system. </li></ul><ul><li>Microeconomic imbalances are another factor. </li></ul><ul><li>Contractual forms of Islamic banking create the liquidity risk. </li></ul>
  8. 8. <ul><li>Salman and Amanat (2008) </li></ul><ul><li>Analyze the comparison in profits of Islamic and conventional banks which is measured by ratio of return on equity. </li></ul><ul><li>It is an empirical study. </li></ul><ul><li>They provides the specific risk management procedures of Islamic banks. </li></ul><ul><li>Concluded that equity based business in Islamic bank face more risk than that of conventional banks. </li></ul><ul><li>Because Islamic banks are new born banks. </li></ul><ul><li>Conventional banks have longer history so the practices that they are using are adequate to mitigate risk. </li></ul>
  9. 9. <ul><li>AbdulMajid and AbdulRais (2003) </li></ul><ul><li>Liquidity management is the larger risk weather for the Islamic or conventional banks. </li></ul><ul><li>It is critical and complex issue. </li></ul><ul><li>Islamic banks relay on the commodity Murabaha for their short term investment and liquidity management. </li></ul><ul><li>Sukuk structure is also being introduced for this purpose. </li></ul><ul><li>Islamic bank can meet their liquidity obligations by smooth operation. </li></ul><ul><li>Emphasizes the close cooperation between the IFI and the central banks. </li></ul><ul><li>To make such instruments that is eligible for the Islamic banks reserve requirements. </li></ul><ul><li>Central banks should hold Sukuk as a part of their portfolio. </li></ul>
  10. 10. <ul><li>Moin </li></ul><ul><li>Analysis between Islamic banks and conventional banks. </li></ul><ul><li>Measured by different financial ratios. </li></ul><ul><li>Islamic banks are less profitable than conventional banks. </li></ul><ul><li>Islamic banks are stated only few years back so their economies of scale is quite low. </li></ul><ul><li>Conventional banks have an experience to handle risks and profits . </li></ul><ul><li>Risks cannot be detached with profits however Islamic banks can improve their liquidity management techniques by improving their practices to mitigate risk. </li></ul>
  11. 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. 12. <ul><li>The nature of data is secondary. </li></ul><ul><li>The source of all the data is from the annual reports of past three years i.e. 2008 to 2010. </li></ul><ul><li>Financial data from these annual reports is used to calculate and to evaluate the liquidity risk management in conventional and Islamic banks of Pakistan. </li></ul>
  13. 13. <ul><li>Following ratios are calculated for this purpose: </li></ul><ul><li>Cash deposit ratio (CDR) </li></ul><ul><li>Current ratio (CA) </li></ul><ul><li>Current asset to total Assets ratio (CATA) </li></ul>
  14. 14. Cash Deposit Ratio = Cash Deposit
  15. 15. Current ratio = Current Asset Current liabilities
  16. 16. CATA = Current Asset Total Asset
  17. 17. <ul><li>Comparative study. </li></ul><ul><li>Study employed two banks. </li></ul><ul><li>Analyze through the ratios. </li></ul><ul><li>Islamic bank has lower deposit ratio. </li></ul><ul><li>The Current ratio of Allied Banks shows increasing trend </li></ul><ul><li>Dubai Islamic bank which shows decreasing trend. </li></ul><ul><li>CATA ratio is lowers in Allied Banks as compared to Dubai Islamic bank. </li></ul>
  18. 18. <ul><li>Conventional banks have better techniques to mitigate the liquidity risk. </li></ul><ul><li>Islamic banks can hedge the liquidity risk. </li></ul><ul><li>They can mitigate it by: </li></ul><ul><li>Internal and external audit. </li></ul><ul><li>GAP analysis. </li></ul><ul><li>By applying new Shariah’ compliant techniques. </li></ul><ul><li>Liquidity management decisions. </li></ul>
  19. 19. <ul><li>Can take other financial institutions. </li></ul><ul><li>Can be analyzed through the experimental procedures. </li></ul><ul><li>Limitation of time and resources. </li></ul><ul><li>Study can also be enhanced through different variable. </li></ul>

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