Liquidity risk and regulation in the Organization of the Islamic Cooperation (OIC) banking industry

Syajarul Imna Mohd Amin,Nurhafiza Abdul Kader Malim,Aisyah Abdul-Rahman

doi:10.21315/aamajaf2021.17.2.2

Syajarul Imna Mohd Amin, Nurhafiza Abdul Kader Malim + Show 1 more

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https://doi.org/10.21315/aamajaf2021.17.2.2

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Abstract

The recurring crises have evidenced poor liquidity risk management and ineffective regulation in banking. Consequently, banking regulations have undergone continuous reforms to bolster stability in the banking system. Nonetheless, theoretical and empirical evidence provide conflicting results that warrant comprehensive research, particularly for emerging Islamic banking. This study examines the role of banking regulation on the liquidity risk of 245 conventional banks and 68 Islamic banks from selected 14 Organization of the Islamic Cooperation (OIC) from 2000 to 2017 utilising the dynamic panel GMM (generalized method of moments) technique. We measure liquidity risk using the Net Stable Funding Ratio (NSFR) and the total financing-to-total deposits and short-term funding (LDEP). Meanwhile, the regulatory measures are asset restriction (AR), private monitoring (PM), supervisory power (SP) and capital requirements (CR). The findings suggest that regulation has a limited impact on bank liquidity risk. The CR supports the value creation of regulation through the reduction in banks’ liquidity risks, while PM and SP are agency costs of regulation that lead to higher liquidity risks. The impact of CR is lower on liquidity risk in Islamic banking than conventional ones, probably due to limited Islamic liquidity risk management facilities. Thus, regulators should strengthen Islamic liquidity risk instruments and markets to facilitate Islamic banking growth.

Highlights

Without prudent liquidity risk management, banks may expose to insolvency and bankruptcy problems in which the effect can be contagious and end up collapsing the entire financial systems (Diamond & Rajan, 2000, 2005; Berger & Bouwman, 2009), like the documentations of many banking failures in the recent global crisis in 2008
We found that Islamic banks are less sensitive to the effect of capital requirements (CR) on liquidity risk compared to conventional banks, as indicated by the significant positive coefficient (IB*CR) in NFSR (LDEP) models
This study analyses the role of banking regulation on the liquidity risk of 245 conventional banks and 68 Islamic banks from selected 14 OIC countries from 2000–2017 using the dynamic panel GMM technique

Summary

Introduction

Technology advancement, financial innovation, globalisation and deregulation have dramatically changed the banking sector throughout the decades (Li, 2019). Without prudent liquidity risk management, banks may expose to insolvency and bankruptcy problems in which the effect can be contagious and end up collapsing the entire financial systems (Diamond & Rajan, 2000, 2005; Berger & Bouwman, 2009), like the documentations of many banking failures in the recent global crisis in 2008. In this regard, liquidity risk management has become the top priority agenda within the policy circle (Otero González et al, 2018). High-capitalised banks with higher riskbearing capacity are exposed to greater capital losses, encouraging banks to practice prudent (low risk) banking activities, conjecturing an inverse capital-

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