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Liquidity risk
Liquidity risk determinants: determinants
Islamic vs conventional banks
Ameni Ghenimi
University of Tunis El Manar – GEF2A Lab-Tunisia, Tunis, Tunisia
65
Hasna Chaibi
University of Tunis El Manar-FCF Lab- Tunis, Tunisia, and Received 27 March 2018
Revised 2 May 2019
Mohamed Ali Brahim Omri 16 May 2020
Accepted 22 July 2020
Northem Border University, College of Business Administration-Saudi Arabia,
Saudi Arabia and University of Tunis El Manar – GEF2A Lab – Tunis, Tunisia

Abstract
Purpose – This paper aims to identify and analyze the similarities and differences of the liquidity risk
determinants within conventional and Islamic banks.
Design/methodology/approach – This study uses a dynamic panel data approach to examine the
relationship between liquidity risk and a set of bank-specific and macroeconomic factors during 2005–2015,
by selecting 27 Islamic banks and 49 conventional ones operating in the MENA region. More specifically, the
dynamic two-step generalized method of moment estimator technique introduced by Arellano and Bond
(1991) is applied.
Findings – The results suggest that the set of bank-specific variables influences the liquidity risk of both
banking systems, while macroeconomic factors determine the liquidity risk of conventional banks. Islamic
banks are not affected by macroeconomic determinants.
Practical implications – The research facilitates to the academicians, practitioners and bankers to have
an alluded picture about liquidity risk determinants and their management. The findings can be used by
bankers’ policy decision-makers to improve and enhance their consideration for liquidity risk management in
both banking systems. Indeed, the study makes them aware to manage liquidity risk differently between
conventional and Islamic banks, as the results reveal different liquidity risk determinants.
Originality/value – Compared to the abundant studies on the determinants of credit risk, researchers have
not sufficiently addressed the factors influencing liquidity risk. Moreover, none of these few research studies
has discussed and compared liquidity risk determinants within both banking systems operating in the Middle
East and North Africa (MENA) region. This leads us to identify the similarities and differences between
conventional and Islamic banks in the MENA region in respect of systematic and unsystematic determinants
of the liquidity risk. The value is attributed to the increasing differentiation between Islamic and conventional
banks. Islamic banks are characterized with a different liquidity structure distinguishing them from their
conventional counterparts.
Keywords Islamic bank, MENA region, Liquidity risk, Conventional bank
Paper type Research paper

Introduction
The risks confronting the banking industry are largely due to the agency relationship
between banks and their depositors. The agency problems that result from this relationship
are responsible for the main banking risk, namely, the credit risk. Nevertheless, bank International Journal of Law and
Management
liquidity also plays an important role in the successful functioning of a bank. Actually, the Vol. 63 No. 1, 2021
pp. 65-95
financial crisis of 2007–2008 revealed shortcomings in the management of liquidity by © Emerald Publishing Limited
1754-243X
financial institutions, which has led to the implementation of the new Basel III framework DOI 10.1108/IJLMA-03-2018-0060
IJLMA regarding liquidity risk measurement introducing new liquidity requirements such as the
63,1 net stable funding ratio and the liquidity coverage ratio. Hence, banks must control their
level of liquidity to absorb losses and strengthen solvency, as it is a significant determinant
of a banking crisis (Hugonnier and Morellec, 2017). Liquidity risk has, therefore, received
considerable attention from policymakers, researchers and practitioners after the recent
economic and financial crisis.
66 Liquidity risk is the inability to fund assets and pay its obligations as they fall due.
According to Adalsteinsson (2014), this risk could perhaps be much more important
than other types of banking risks as it can may trigger insolvency risk or “bank run,”
especially when it comes to the banks’ inability to provide withdrawals to the
depositors at the moment it is needed. According to Horvath et al. (2016), to create
liquidity, it is necessary for banks to finance relatively illiquid assets with relatively
liquid liabilities. In other words, to facilitate transactions among economic agents and
support economic activity, a short-term liquid deposit have to fund long-term illiquid
lending. Moreover, the experience of banks in several countries around the world,
which are facing liquidity pressures, has revealed the importance of liquidity risk to be
managed effectively.
Liquidity risk constitutes an important risk type within both Islamic and conventional
banks. Abdul-Rahman et al. (2018) and Shamsuddin and Safiullah (2018) point out that like
conventional banks, Islamic banks are also exposed to liquidity risk. Nevertheless, the
prohibition of interest-based borrowing in Islamic banks has limited the ability of these
banks to manage their liquidity positions as effectively as their conventional counterparts.
Indeed, Islamic banks may face liquidity risk, which arises because of the limited
accessibility to the money market conforming to Sharia principles which makes it harder for
Islamic banks to raise funds during liquidity shortage. Actually, the prohibition for these
banks of any payment or receipt of interest which means they can only invest in Sharia-
compliant instruments. Islamic banks, for instance, cannot invest in short-term financial
instruments such as treasury bills or borrow from other banks or financial institutions. On
the other hand, if we believe that Islamic banks are enjoying liquidity surplus, Aliyu et al.
(2017) show that the liquidity excess in Islamic banks cannot assure the solidity and the
success of these institutions. Islamic banks are characterized with a different liquidity
structure distinguishing them from their conventional counterparts [1]. This might push
bank managers to understand and know the main sources affecting their liquidity risk to get
an alluded picture about banking developments in liquidity risk management.
Consequently, all these sources have aggravated the challenges for the Islamic and
conventional banks to be managed constantly and effectively their liquidity risk through
staff monitoring of the liquidity risk involved factors.
To that effect, we try to clarify and analyze the various liquidity risk determinants to
improve risk management in both banking systems, whether the interest-free banks behave
differently from the interest-based ones. Against this backdrop, the objective of this study
consists of assessing liquidity risk determinants within the Islamic banking industry
compared to the conventional counterpart. The undertaken analysis covers bank-specific
and macroeconomic environmental factors to ascertain liquidity risk correlates. Our study is
conducted on a sample of 76 banks operating in the Middle East and North Africa (MENA)
region and observed over 11 years (i.e. from 2005 to 2015). We have chosen the MENA
countries where Islamic banks operate alongside and compete with their conventional
counterparts. To achieve our aim, we adopt two-step generalized method of moment (GMM)
system analysis.
 Previous studies have largely been conducted on liquidity creation and bank risk- Liquidity risk
taking (Berger and Bouwman, 2009; Drehmann and Nikolaou, 2013; Lei and Song, 2013; determinants
Vazquez and Federico, 2015; Horvath et al., 2016; Ippolito et al., 2016; Umar et al., 2016;
Khan et al., 2017; Nadeem, 2017; Dahir et al., 2018; Milcheva et al., 2019). Nevertheless, a
small number of studies have examined the determinants of liquidity risk, even less in
Islamic banks. We can note Munteanu (2012), Moussa (2015) and Roman and Sargu
(2015), who test the liquidity risk determinants in conventional banking system and 67
Alzoubi (2017) in Islamic one. In addition, there is no relevant research that attempted to
address the liquidity risk determinants issue in both types of banks. We note Abdul-
Rahman et al. (2018), who investigate and compare the impact of one determinant, namely
the financing structure, on liquidity risk in Islamic and conventional banks operating in
Malaysia. Moreover, exploring such an effect through a comparative analysis between
Islamic and conventional banks in the MENA region is, to our knowledge, not so far
satisfactory explored, which would certainly make the present work’s major provided
contribution. In fact, the intention lies in filling the gap perceived in the liquidity risk
literature, by providing some insights into the regulatory, effective management strategy
and supervisory framework through extracting the internal and external factors affecting
liquidity risk.
This study is also conceived to contribute to the banking literature in several ways. First,
our study is the first that analyzes and provides an in-depth comparison of the liquidity risk
determinants within both types of banks in the MENA region covering a period (2005–2015)
that includes the global financial crisis. Second, the study considers two different categories
of determinants, namely macroeconomic and bank-specific factors simultaneously using
two different data sets. Actually, existing studies on liquidity risk determinants, either
consider bank-specific or macroeconomic ones separately. Moreover, our study is the first
that uses the liquidity gap variable as liquidity risk determinant. Third, we use a dynamic
panel data approach introduced by Arellano and Bond (1991) to the MENA banking
systems. The advantage of this approach is to solve the problems of parameter estimates
which are bias and inconsistent due to the presence of lagged dependent variable or
potential endogeneity problem created by explanatory variables.
The remainder of the study will be organized as follows: Section 2 presents the literature
review. Section 3 outlines the data and methodology. Section 4 reports and discusses the
empirical results. Section 5 concludes the research and offers some policy implications.

Literature review and hypotheses development

Previous studies suggest that there are two streams of literature on the factors that cause
liquidity risk. The first line suggests that liquidity risk is driven by bank-specific variables
and the second argues that macroeconomic factors may also influence banks’ liquidity risk.
Most research studies (Diamond and Dybvig, 1983; Molyneux and Thornton, 1992;
Kosmidou, 2008; Bissoondoyal-Bheenick and Treepongkaruna, 2011) test the bank liquidity
risk management taking into account the serious implication for the overall macroeconomic
and financial stability. After the financial crisis of 2007, researchers, regulatory and
policymakers have granted an increasingly interest to this theme. Nevertheless, the
literature on the determinants of liquidity risk is relatively scarce.
The selected variables to explain liquidity risk are based on the literature and the theory.
We report in Appendix B that all variables used in prior studies to explain liquidity risk and
underlying findings.
IJLMA Macroeconomic determinants
63,1 Few papers in the banking literature examine the relationship between macroeconomic
factors and bank liquidity. We can cite Dinger (2009) and Moussa (2015).

Inflation rate
Inflation is a measure of the general prices level of a country, which is negatively influenced
68 by the purchasing power of a national currency. Governments and central banks should
maintain low levels of inflation to keep the economy running smoothly. Empirical studies on
liquidity risk determinants indicate inconclusive results concerning the inflation factor.
Vodova (2011), for instance, investigates the liquidity determinants of Czech Republic banks
and shows that inflation has positive impact on liquidity risk. Nonetheless, Horvath et al.
(2014) find that the inflation rate has insignificant effect on the banks liquid assets. Moussa
(2015) examines the determinants of Tunisian banks liquidity and finds that the impact of
inflation rate on liquidity risk depends on the methodology adapted [2], while changes in
inflation rate are inversely related to bank liquidity. More recently, comparing the liquidity
risk determinants between Islamic and conventional banks in Malaysia, Sukri and
Waemustafa (2016) conclude that the inflation rate/liquidity risk relationship is positive in
Islamic banks, whereas it is not statistically significant in conventional banks.
Theoretically, the effect of the inflation on liquidity risk is expected to be positive. First,
the banking liquidity position is very sensitive to inflation fluctuation, as higher inflation
can deteriorate the borrowers’ ability to serve debt by reducing their real income (Nkusu,
2011). Therefore, increasing inflation rate and sudden fluctuations increase the level of non-
performing loans for banks. Second, based on the theory financial intermediation (Bryant,
1980; Diamond and Dybvig, 1983) and the industrial organization approach to banking
(Prisman et al., 1986), Samartin (2003) and Iyer and Puri (2012) show that liquidity and credit
risk should be positively related. Actually, if a great number of failed economic projects are
funded through loans, the bank will not be able to meet the demand of the depositors, who
will claim back their money as these assets depreciate. This implies that liquidity and credit
risks increase simultaneously (Diamond and Rajan, 2005; Ghenimi et al., 2017), values of
collateral security deteriorate and loan repayments value on banks loans decreases, leading
to a lower liquidity for bank. Hence, the formulation of our first hypothesis is as follow:

H1. Inflation rate indicator is positively related with liquidity risk.

Gross domestic product growth

Studies examining the liquidity risk in conventional banks (Bunda and Desquilbet, 2008;
Dinger, 2009; Cucinelli, 2013; Moussa, 2015). Bunda and Desquilbet (2008) show that GDP
growth has a positive effect on the level of liquidity holdings in a bank. This result is in
contrast with Dinger (2009), where GDP growth is negatively related in banks operating in
the Central and Eastern European emerging economies (Bulgaria, Czech Republic, Estonia,
Hungary, Latvia, Lithuania, Poland, Romania, Slovakia and Slovenia). This result is similar
to Cucinelli (2013) who finds a positive impact of GDP growth on liquidity risk. Later,
Moussa (2015) shows that changes in GDP growth are inversely related to bank liquidity. He
shows that expansionary economy provides a good opportunity for banks to create more
income, therefore, decreasing their exposure to the liquidity risk.
Besides that, only a few studies examine and compare liquidity risk determinants for
Islamic and conventional banks. Abdul-Rahman et al. (2018) examine the effect of financing
structure on liquidity risk within both types of banks operating in Malaysia over 1994–2014
period, show a significant negative relationship between GDP growth and liquidity risk. Liquidity risk
This result is consistent with the result obtained by Yaacob et al. (2016) in Islamic context determinants
and contrary to the result obtained by Sulaiman et al. (2013) in Islamic context.
GDP growth implies the business cycle of an economy of a country where the
investments and economic developments of a country are highly impacted by the banking
liquidity functions. Actually, financial instability and liquidity problems evolve with the
different economic growth levels (Gaytan and Rancière, 2001). This is explained by the fact
that when access of both types of banks to the capital markets or interbank funding is 69
limited, this opens up the possibility that banking liquidity holding may be related to the
business cycle. In the other hand, it is conceivable that banks hoard liquidity to reduce the
amount of external debt during economic downturn and that they run down liquidity
buffers during economic expansions. During this period, the level of investment increases,
which they facilitate growth within the economy and that banks have more willing to lend
out money because they know that business and entrepreneurs are able to repay their loans.
The GDP growth is an indicator to measure the demand for banking services in the context
of receiving deposits and providing financing. Theoretically, a higher GDP growth increases
liquidity of bank as citizens have more money circulated in the financial market, thus,
decreasing liquidity risk. Conversely, during a recession, individual and corporate
borrowers need not sufficient funds to service their debts, resulting in an increase in
liquidity risk. The following hypothesis may be formulated:

H2. GDP growth indicator is negatively related with liquidity risk.

Financial crisis
Since the financial crisis of 2007, academicians and researchers have moved to focus on the
effect of financial crises on the stability of banks of which liquidity is an important
constituent. Bunda and Desquilbet (2008) and Vodova (2011) find a negative correlation
between financial crisis and bank liquidity. Indeed, financial crisis could be caused by poor
bank liquidity while the inverse relation may also hold true. The reasons for which financial
crisis may cause poor bank liquidity are: the volatility of vital macroeconomic factors could
lead to unfavorable business environment for bank; and economic instability might worsen
the business environment of the borrowers and affect their ability to make loan repayments,
ultimately leading to a decline in bank liquidity, increasing in an liquidity risk. Ben Saleh
and Boujelbene (2018) show a negative effect of financial crisis on the liquidity of
conventional and Islamic banks operating in the MENA region. Consequently, the following
hypothesis is enunciated:

H3. Financial crisis indicator is positively related with liquidity risk.

Bank specific factors

The determinants of liquidity risk should not be sought exclusively among macroeconomic
factors, which are exogenous to the bank. Examining the specific-bank factors is so
important for bank to improve the risk management. A strand in the literature investigates
the relationship between bank-specific factors and liquidity risk.

Credit risk
A review of the empirical literature reveals few attempts to examine the liquidity risk in
Islamic banks. Regarding conventional banks, a first body of empirical studies focuses on
IJLMA how the credit risk perceived during the financial crisis can lead to liquidity risk in banks
63,1 (Diamond and Rajan, 2005; Acharya and Viswanathan, 2011; Gorton and Metrick, 2012; He
and Xiong, 2012; Munteanu, 2012). They show a positive relationship between liquidity and
credit risks. These studies suggest that if too many troubled economic projects are financed
through bank loans, they cannot, therefore, satisfy the demand of depositors. Actually, if
these assets lose value, more and more depositors will claim their money. Thus, a higher
70 credit risk will lead to a higher liquidity risk through the channel of depositors’ demand.
A second body of empirical study focuses on the interaction between liquidity and credit
risks and their implications on the banking stability. Imbierowicz and Rauch (2014), for
instance, examine the relationship between liquidity risk and credit risk for a sample of US
commercial banks over the 1998–2010 period. They show that there is a positive impact of
credit risk on liquidity risk and not a reciprocal relationship between the two categories of
risk. Nevertheless, Ghenimi et al. (2017) use a sample of 49 banks operating in the MENA
region over the period 2006–2013 to analyze the relationship between credit risk and
liquidity risk and its impact on bank stability. They reveal a negative impact of credit risk
on bank liquidity, suggesting that credit risk is high, bank will reduce liquidity by investing
in less liquid relatively high yield securities.
Meanwhile, Iqbal (2012) studies the comparison for liquidity risk determinants between
Islamic and conventional banks in Malaysia over the 2007–2010 period. He shows a negative
impact of credit risk on liquidity risk within both types of banks. This result implies that
credit risk causes an increase in liquidity risk resulted from banks having a huge amount of
low quality debt and because a large number of bad debts reduce liquidity position of the
banks.
The classic theories of the microeconomics of banking such as the Monti-Klein
framework and the financial intermediation perspective evince that there is some
relationship between liquidity and credit risks (Bryant, 1980; Diamond and Dybvig, 1983).
For instance, according to Dermine (1986), credit risk increases liquidity risk due to lower
cash inflows and depreciation it triggers. Actually, an asset and liability structures of bank
are closely related, precisely, with the case of the fund withdrawals and borrower defaults.
This holds true not only for balance sheet business of banks but also for the lending and
funding business conducted through off-balance sheet items. The following hypothesis may
therefore be formulated:

H4. Credit risk is positively related with liquidity risk.

Bank capitalization
The process of capital formation is vital to banking industry regardless of the nature of
bank. Capitalization may be related to liquidity risk. Greater capital means that bank will
face less trouble or risky situation. Opposing theories can be advanced regarding the
relationship between capital and liquidity creation. Berger and Bouwman (2009) point out
two different theories. The first “financial fragility-crowding out” hypothesis implies that
capital is negatively related to liquidity creation. This hypothesis is also explained by
Diamond and Rajan (2000), where banks collect funds from depositors to issue loans, which
contribute to the bank fragility. In addition, in case of the absence of complete deposit
insurance, the financial structure of banks becomes fragile but they must have a large share
of liquid deposits to gain confidence of their depositors and hence decrease the likelihood of
a bank run. This is also explained by the fact that banks prefer to lift deposits to grant loans
to increase liquidity creation. Therefore, banks that have a higher regulatory capital may
experience lower liquidity creation. However, the second “risk absorption out” hypothesis
suggests that regulatory capital is positively related to liquidity creation. Actually, Liquidity risk
according to Allen and Gale (2004), liquidity creation raises the exposure of banks to risk determinants
because banks that create high liquidity face greater losses when they are forced to sell
illiquid assets to satisfy the customer’s liquidity demands. On the other hand, according to
Repullo (2004), high capital allows the bank to absorb greater risk.
A review of the empirical researches reveals few attempts to investigate the liquidity risk
determinants in commercial banks. For instance, Roman and Sargu (2015) analyze the
impact of bank-specific factors on the commercial banks liquidity in Central and Eastern
71
Europe over the 2004–2011 period. They show that there is a negative relationship between
capitalization and liquidity, and thus a positive relationship between liquidity risk and
capitalization. This relationship is explained by the fact that the shareholders of the banks
that use a large amount of equity will put great pressure on the managers. Munteanu (2012)
examines the liquidity in 27 Romanian commercial banks over the 2002–2010 period and
shows that the capital adequacy ratio has a positive impact on the liquidity risk. This result
suggests that greater capital implies that banks had enhanced liquidity risk managing.
In the Islamic context, Iqbal (2012) studies the determinants of liquidity risk of Islamic
and conventional banks in Malaysia over the 2007–2010 period and finds that capital
adequacy ratio (CAR) has a positive and significant impact on the liquidity risk for both
types of banks. Actually, a large capital adequacy ratio means that banks have a large
capital, which means that capital can be used to cover their due dates and therefore they will
have fewer difficulties in a risky condition. On the contrary, Chagwiza (2014) finds that
capital adequacy ratio has a negative impact on the liquidity risk within conventional and
Islamic bank operating in the Bangladesh from the period 2003 to 2006. This result is
consistent with the results obtained by Alzoubi (2017), Abdul-Rahman et al. (2018) and
Yaacob et al. (2016). Overall, the theoretical and empirical literature finds that banks with
larger capital buffers are less willing to take liquidity risk compared to those that are not
well-capitalized. The following hypothesis may be formulated:

H5. Bank capitalization is negatively related with liquidity risk.

Bank profitability
The relationship between bank performance and liquidity risk is ambiguous in its direction.
Performance means the ability of the company in making a profit to shareholders which
greater performance means banks have good revenue that it can be used to cover their short-
term obligations. There is only one study (Alzoubi, 2017) analyzing the liquidity risk in
Islamic banks over the 1994–2009 period and shows that ROA ratio has a positive impact on
liquidity risk. This result suggests that higher performance means a higher liquidity risk.
This result also implies that the banks face greater liquidity risk because they shift their
portfolio about more profitable assets to raise their incomes.
Second empirical studies test the liquidity risk determinants in Islamic banks compared
to conventional banks. For instance, Effendi and Disman (2017) investigate the determinants
of liquidity risk in 20 Islamic and 12 conventional banks over the 2009–2015 period. They
show that return on assets has a positive impact on liquidity risk in conventional banks but
it is not a liquidity risk determinant in Islamic banks. Additionally, Iqbal (2012) finds a
positive impact of profitability on liquidity risk. These results suggest that better
performance confirmed that conventional banks had enhanced profitability and liquidity
risk managing as compared to Islamic counterparts. Recently, Ben Saleh and Boujelbene
(2018) investigate the determinants and the joint relationship between capital, risk and
IJLMA liquidity of 88 conventional banks and 42 Islamic ones for the period 2005–2013. They show
63,1 that ROA has a negative impact on the liquidity risk for both types of banks.
A review of the empirical literature reveals few attempts to examine the liquidity risk
determinants in commercial banks. Al-Khouri (2011) shows that liquidity risk is explained
mostly by return on asset. Nevertheless, Roman and Sargu (2015) study the liquidity of
commercial banks in Central and Eastern Europe over the 2004–2011 period. They show a
72 negative impact of profitability to liquidity risk. They point out that the negative relationship
may be jointly attributed to supervision regulations and bank’s shareholders’ business strategies
that practice less stringent liquidity requirement. Other than that, the negative influence of
profitability on liquidity risk should result due to the fact that high profitability banks are likely
to have better reputation and credibility to access funding and asset marketability, thereby able
to manage liquidity problem better. Based on the literature above, liquidity risk and bank
profitability should thus be negatively correlated. The next hypothesis is enunciated:

H6. The banking profitability is negatively related with liquidity risk.

Bank size
Empirical studies on the relationship between bank size and liquidity risk are also mixed.
By examining 42 Islamic banks from 15 countries between 2007 and 2014, Alzoubi (2017)
shows that bank size is negatively related to liquidity risk. Nevertheless, Vodova (2011)
provides an analysis for Czech commercial banks over the period 2001 to 2009. He concludes
that bigger banks present lower liquidity, which is in line with the “too big to fail”
assumption. Actually, bigger banks are less motivated to hold liquidity because they rely on
government intervention in case of shortages.
The bank size is introduced to account for existing economies of scale in the banking
industry. The relationship between size and liquidity risk is an important part of the firm’s
theory. Actually, larger banks tend to maintain a lower level of liquidity reserves, as banks’
size lowers liquidity risk which these banks can supply greater confidence to their
customers (Vodova, 2011). We seek to analyze the validity of the “too big to fail” assumption
under our both types of banks. In this way, we draw our sixth hypothesis positing that the
relationship between liquidity risk and bank’ size is positive, as follows:

H7. The bank size is positively related with liquidity risk.

Liquidity gap
The assets majority are funded with deposits most of which are current with a possibility to
be called at any time. According to Brunnermeier and Yogo (2009), this is known as the term
structure mismatch between assets and liabilities. Actually, commercial banks must
maintain a certain degree of mismatch to improve efficiency of the use of money, but the
excessive maturity mismatch between assets and liabilities is one of the main causes of
liquidity risk in the banking sector. This mismatch is called liquidity gap and can be
measured by the maturity gap between assets and liabilities (Falconer, 2001). The liquidity
gap has a strong relationship with banking liquidity risk. Greater of liquidity gap means
banks have higher liquidity risk while, lower as this ratio means banks have a lower
liquidity risk (Goodhart, 2008; Goddard et al., 2009). We then presume that this factor may
be an important indicator of liquidity risk. In this context, liquidity risk and liquidity gap
should thus be positively correlated. Hence, our last hypothesis is the following:
 H8. Liquidity gap is positively linked to liquidity risk. Liquidity risk
Furthermore, most papers analyze liquidity risk management, liquidity creation or bank determinants
risk-taking. The impact of macroeconomic and bank-specific factors on liquidity risk is not
the subject of studies on Islamic banks. To our knowledge, this is the first study that deals
with this issue in a comparative analysis between Islamic and conventional banks. Hence,
we contribute to the literature to fill this gap by investigating the liquidity risk determinants
in both types of banks. 73
Data and methodology
Data description
The main objective of this study is to identify the liquidity risk determinants within both
types of banking systems. In accordance with the prior literature review, we retain two
kinds of variables: bank-specific and macroeconomic determinants. The study data include
Islamic and conventional banks operating in the MENA region. Our focus on the MENA
region is justified by the fact that Islamic banking is well developed there. The reason for
limiting the data in this way is to provide a better analysis of Islamic banking of the Arab
countries. Our primary analysis over the period 2005–2015 includes 27 Islamic banks and 49
conventional banks from 9 countries, namely, Bahrain, Egypt, Jordan, Kuwait, Qatar, Saudi
Arabia, Turkey, United Arab Emirates and Yemen. The corresponding banks are listed in
Appendix C. The main data sources are collected from the audited annual financial report of
each bank. The data on the bank annual reports are taken from the basic electronic banking
data of the Van Dijk Bureau (Bankscope). However, the data on the macroeconomic
variables are obtained from the World Bank development indicators.

Variables description
Dependent variable: liquidity risk. The dependent variable is liquidity risk denoted by the
inverse of bank liquidity. Bank liquidity is measured by the ratio of liquid assets to total
assets. We adopt this proxy for the liquidity as it is the most popular indicator of bank
liquidity. Simply, liquidity risk is the opposite of liquidity which is the inability to fund
assets and pay its obligations as they fall due. Higher liquidity indicates less banking
liquidity risk. In this context, Aydemir and Guloglu (2017) measure the liquidity risk by (1/
(liquid assets/total assets)).
Independent variables. In this paper, we focus on the liquidity risk determinants within
both banking systems, using a set of macroeconomic variables such as inflation rate, GDP
growth and financial crisis and bank-specific factors, namely credit risk, banking
capitalization, profitability, bank size and liquidity gaps. The choice of these variables is
motivated by the fact that they are under the control of the management of the bank.
Therefore, one could analyze how these internal and external factors influence liquidity risk.
Macroeconomic variables are defined using information on inflation rate, economic
growth and financial crisis. Inflation rate is measured by the growth of the consumer price
index. Economic growth is represented by the natural logarithm of the real rate of GDP
growth. Financial crisis is a dummy variable denoting unit for 2007 to 2008 and zero for
2005, 2006 and 2009 to 2015.
Credit risk is measured by the ratio of non-performing loans to total gross loans (NPL).
On the basis of the definition, a decrease of doubtful loans suggests an improvement of the
quality of banking assets. Thus, higher NPL ratio indicates higher banking credit risk. This
ratio is considered the principal strength pillar of banks to indicate signs of raised financial
vulnerability.
IJLMA Bank capitalization is calculated as the ratio of equity to total assets (CAR). A large CAR
63,1 means that banks have a large capital, which means that the principals can be used to cover
their due dates and the bank will have fewer difficulties in a risky condition, therefore, they
have lower liquidity risk.
Profitability of banks is measured by the return on equity (ROE), which is defined as the
ratio of net income to equity. In fact, profitable banks mean that they have large gains to use
74 to cover their obligations. This means that banks will have fewer difficulties or risky
situations. Therefore, the proxy aim to measure the opportunity cost of banking liquidity.
Bank size is defined using the logarithm of the total assets of the bank (SIZE). This
variable is used as determinants of liquidity risk because the large conventional banks can
reduce their liquidity risk, therefore, these banks can supply greater confidence to their
customers. Contrary, small Islamic banks can reduce their liquidity risk than large Islamic
banks.
Liquidity gap is measured by the disparities between assets and liabilities that cause
liquidity risk. A large liquidity gaps means that banks have more liquidity risk and vice
versa. In addition, this report gives a signal to the banks with a reduction of risks. Our study
is the first that uses the liquidity gap variable as liquidity risk determinant.
The choice of the variables above purposes for determining an instrument to supply
information on the liquidity risk determinants in Islamic and conventional banks. Table 1
presents all of these variables.

Methodology
Following the recent literature on liquidity risk (Dinger, 2009; Munteanu, 2012; Alzoubi,
2017), we adopt a dynamic approach to account for the time persistence in the liquidity risk
structure. The following model is applied to measure the liquidity risk of our sample:

X
J X
L
LRi;t ¼ C þ d LRi;t1 it1 þ b j Bankji;t þ b l Macrolt þ E i;t (1)
j¼1 l¼1

where i represents the bank (in our study, we have 27 Islamic banks and 49 conventional
banks); t represents the time (our time frame is 2005–2015), LRi,t represents liquidity risk (i.e.
the inverse of banking liquidity) for a specific bank at a specific year and LRi,t–1 is the first

Variable Notation Definition Expected sign

Dependent variable
Liquidity risk LR 1/Liquid assets to total assets ratio
Independent variables
Inflation INF Consumer price index Positive
GDP growth GDP GDP growth (real rate of GDP growth) Negative
Financial crisis Financial crisis = 0 during 2005, 2006 and Positive
2009 to 2015 and financial crisis = 1 for
the 2007 to 2008 period
Credit risk NPL Impaired loans/gross loans Positive
Capital adequacy ratio CAR Equity to total assets Negative
Profitability ratio ROE Net income to equity Negative
Table 1. Size Size Natural logarithm of total assets Positive
Variables definitions Liquidity gap Log (assets - liabilities) Positive
lagged dependent variable which captures the persistence in liquidity risk over time. Bankji;t Liquidity risk
refers to bank-specific variables namely loan quality indicator (i.e. credit risk proxy: NPLi,t), determinants
capital adequacy ratio (CARi,t), returnon equity  (ROEi,t), bank size (Sizei,t) and liquidity
gapi,t. Three macroeconomic variables Macrolt are also used that are the annual inflation
rate (INFi,t), the annual real rate of GDP growth (GDPi,t) and financial crisis dummy (crisisi,t)
to verify for the possible pressure in the 2007–2008 financial crisis period. Finally, j it stands
for an idiosyncratic error term. b j and b 1 are coefficients to be estimated employing the
GMM system estimator developed by Blundell and Bond (1998). 75
We choose this estimator for four reasons. First, the use of panel of the ordinary least
squares (OLS) estimator (with fixed and random effects) provide parameter estimates which
are bias and inconsistent due to the presence of lagged dependent variable (i.e. lagged
liquidity risk) or potential endogeneity problem created by explanatory variables (Nickell,
1981; Harris and Matyas, 2004). In this context, system GMM estimator proposed by
Arellano and Bover (1995) and Blundell and Bond (1998) solve these problems.
Second, system GMM estimation is the efficient method since provides efficient and
consistent estimates even if arbitrary heteroskedasticity and autocorrelation within
individuals exist and if independent variables are not strictly exogenous. Third, the
difference-GMM estimator is less efficient than system-GMM estimation since it uses not a
system which combines regressions of levels and first differences. As the original equation
in levels is instrumented with lagged first differences of the variables, so the system-GMM
estimation allows employing more instruments while first differenced equation is
instrumented with the lagged levels of variables. Moreover, Roodman (2009a) notes that first
differences are assumed to be instruments but not correlated with the fixed effects.
Roodman (2009b) notes that the difference and the system GMM can lead to a different
conclusion. In this framework, system-GMM estimation gives better results than difference
GMM where the data is unbalanced panel because difference GMM magnifies the gaps.
Fourth, according to Blundell and Bond (1998), the system GMM estimator is more efficient
in the case where the number of time periods is little and the persistence independent
variable very correlates with the autoregressive term that is close to unity. However, most of
the diagnostic tests discussed in this paper can be cast in a GMM framework. The Hansen
test is so employed to test the over-identifying restrictions to detect if the model is well
specified or not and to provide the validity of instruments. The null hypothesis of the
validity of over identification restrictions cannot be rejected. This suggests that the
instruments used are valid. In addition, the test of first-order serial correlation [AR (1)] and
second-order serial correlation [AR (2)] was used to test in generally the serial correlation.
That is, the null hypothesis which means that there is no [AR (1)] should be rejected,
whereas null hypothesis which means that there is no [AR (2)] should not be rejected. The
instruments’ validity of autocorrelation cannot be rejected.

Results and interpretations

Descriptive statistics
We applied the descriptive statistics of liquidity risk and each factor, including inflation
rate, GDP growth, financial crisis, non-performing loans (credit risk), CAR, ROE, banks size
and liquidity gap of Islamic and conventional banks in the MENA region. The descriptive
statistics of the mean value and the standard deviation (Std.dev) of these different variables
are presented in Table 2.
With regard to our dependent variable which is LR, Islamic banks shows a low liquidity
risk which indicate that interest-free banks are more liquid relative to the interest-based
banks. However, one can conclude that the effect of the current financial crisis has harmful
IJLMA Conventional banks Islamic banks
63,1 Variable Mean SD Mean SD

Liquidity risk 10.775 0.091 0.134 0.390

Inflation rate 2.102 0.129 2.097 0.248
GDP growth 5.659 4.870 5.275 4.992
Financial crisis 0.182 0.387 0.182 0.387
76 NPL 5.303 9.391 10.060 17.374
CAR 11.766 13.455 36.177 90.156
ROE 11.005 24.566 5.913 15.623
Size 4.032 0.853 3.987 1.195
Table 2.
Liquidity gap 3.154 0.858 3.034 0.975
Descriptive statistics
of the liquidity risk Notes: Std.dev is standard deviation, NPL is non-performing loans ratio, CAR is capital adequacy ratio,
determinants ROE is return on equity

effect for the interest-based banks as compared to the interest-free banks one. We notice that
Islamic banks show a higher credit risk, capital and ROE than their conventional banking
ones. Finally, we also document that conventional banks find a higher liquidity gap,
inflation rate, GDP growth and size than their Islamic banks.
Table 3 outlines the value of correlations for variables in Islamic banks. The table below
shows that there is a low correlation between independent variables. Nevertheless, we
observe that size and liquidity gap have a relatively high correlation (0.736).
Table 4 of correlation matrix exposes correlation coefficients between independent
variables for conventional banks. The results to high correlation are found among variables
for conventional banks are identical to those found for Islamic banks, such as the size and
liquidity gap (0.973). To overcome the problem of multicollinearity, to introduce both
determinants separately.

Results of generalized method of moment dynamic model

Table 5 below presents the empirical results of the estimation of model (1) using two
different specifications for each type of bank ((1) through (2)) where we include and/or
exclude a critical independent variable in each case. After trying these specifications, we end
up with these four main specifications, which pass all the econometric concerns discussed in
the methodology section above. Therefore, the model appears to fit the dynamic panel data
well, since all relevant tests are highly significant as presented below in Table 5. We are
interested using the GMM-system estimator, more specifically with the use of the GMM-
system estimator of Arellano and Bond (1991), Arellano and Bover (1995) and Blundell and
Bond (1998) to verify the existence of the effect of the explanatory variables on the liquidity
risk within both banking systems. Table 5 presents the results of the Hansen test for the
most restriction identification and the AR (2) of the second-order correlation series.
According to Table 5 (Columns 1 and 2) for Islamic and conventional banks, the Hansen test
with a p-value much greater than 0.1, which means that the null hypothesis H0 of the
validity of over identification restrictions (validity of instruments) cannot be rejected. It can
therefore be concluded that the instruments used for this regression are valid, thus inducing
the validity of the results. The second-order autocorrelation tests of disturbances of Islamic
and conventional banks show that the values (1.20, 1.21) and (0.71, 0.65), respectively with
respective p-values of (0.229, 0.228) and (0.477, 0.515). This means that we reject the
hypothesis of the absence of first-order autocorrelation of errors, but we cannot reject the
 Liquidity Inflation Liquidity
risk rate GDP Cisis NPL CAR ROE Size gap

Liquidity risk 1.000

Inflation rate 0.040 (0.487) 1.000 0.023
GDP 0.126* (0.029) (0.684) 1.000
Crisis 0.027 (0.640) 0.117* (0.042) 0.088 (0.129) 1.000
NPL 0.104 (0.072) 0.099 (0.087) 0.023 (0.686) 0.055 (0.342) 1.000
CAR 0.081 (0.162) 0.040 (0.485) 0.157* (0.006) 0.073 (0.2) 0.515* (0.000) 1.000
ROE 0.074 (0.202) 0.034 (0.549) 0.0814 (0.161) 0.131* (0.023) 0.148* (0.010) 0.032 (0.572) 1.000
Size 0.074 (0.201) 0.133* (0.021) 0.002 (0.961) 0.108 (0.062) 0.016 (0.771) 0.114* (0.048) 0.063 (0.273) 1.000
Liquidity gap 0.059 (0.307) 0.020 (0.730) 0.053 (0.356) 0.074 (0.201) 0.095 (0.099) 0.186* (0.001) 0.101 (0.080) 0.736* (0.000) 1.000

Notes: NPL is non-performing loans ratio (credit risk), CAR is capital adequacy ratio, ROE is return on equity, GDP is economic growth. *denotes significance
at 5%

banks
matrix: Islamic
Pairwise correlation
Table 3.
77
determinants
Liquidity risk
 78
63,1

banks
IJLMA

Table 4.
Pairwise correlation
matrix: conventional
Liquidity Inflation Liquidity
risk rate GDP Crisis NPL CAR ROE Size gap

Liquidity risk 1.000

Inflation rate 0.187* (0.000) 1.000
GDP 0.091* (0.034) 0.118* (0.005) 1.000
Crisis 0.071 (0.098) 0.009 (0.983) 0.102* (0.017) 1.000
NPL 0.093* (0.029) 0.024 (0.577) 0.189* (0.000) 0.094* (0.028) 1.000
CAR 0.070 (0.104) 0.030 (0.480) 0.118* (0.005) 0.023 (0.586) 0.554* (0.000) 1.000
ROE 0.061 (0.156) 0.051 (0.234) 0.002 (0.996) 0.026 (0.539) 0.056 (0.191) 0.527* (0.000) 1.000
Size 0.060 (0.158) 0.025 (0.560 0.026 (0.536) 0.030 (0.481) 0.137* (0.001) 0.059 (0.168) 0.011 (0.796) 1.000
Liquidity gap 0.046 (0.283) 0.064 (0.137) 0.029 (0.488) 0.056 (0.191) 0.152* (0.004) 0.039 (0.365) 0.064 (0.137) 0.973* (0.000) 1.000

Notes: NPL is non-performing loans ratio (credit risk), CAR is capital adequacy ratio, ROE is return on equity, GDP is economic growth. *denotes significance
at 5%
 Dependent variable: LR
Liquidity risk
Islamic banks Conventional banks determinants
(1) (2) (1) (2)

Lag LR 0.902*** (0.000) 0.903*** (0.000) 0.336*** (0.000) 0.428*** (0.000)

Inflation rate 0.616 (0.268) 7.516 (0.278) 2.871*** (0.000) 4.166*** (0.000)
GDP 0.982 (0.217) 0.120 (0.132) 0.112*** (0.006) 0.152** (0.042)
Crisis 2.678 (0.143) 2.096 (0.216) 3.327*** (0.000) 2.895*** (0.000) 79
NPL 0.284*** (0.000) 0.479*** (0.000) 0.056** (0.029) 0.048** (0.012)
CAR 2.733*** (0.002) 1.699*** (0.000) 0.124*** (0.000) 0.031 (0.224)
ROE 13.647*** (0.004) 13.266*** (0.000) 0.038*** (0.005) 0.014*** (0.008)
Size  0.159*** (0.000)  0.676 (0.123)
Liquidity gap 7.862*** (0.000) – 12.184*** (0.000) 
AR(2) 1.20 1.21 0.71 0.65
p-value 0.229 0.228 0.477 0.515
Hansen test 26.46 25.83 34.67 26.32
p-value 0.601 0.135 0.216 0.121

Notes: LR is liquidity risk, NPL is non-performing loans ratio (credit risk), CAR is capital adequacy ratio,
ROE is return on equity, GDP is economic growth Hansen test, if more identifications restrictions are valid,
the null hypothesis is valid. The AR (2) test of second-order serial correlation, and the null hypothesis is that
there is no serial correlation. *, **, *** indicate 10%, 5% and 1% significance levels, respectively. () indicate Table 5.
p-value The GMM method

hypothesis of the absence of the second order. This implies that the empirical model has
been correctly specified because there is no serial (autocorrelation) correlation in the
transformed residues; therefore the instruments used in the models are valid. In addition, we
notice that the lagged dependent variable is positive and significant across all specifications,
which prove the dynamic character of model specification (Daher et al., 2015). Therefore, we
validate the choice of a dynamic specification for our model. The results are presented in
Table 5 below.
According to Table 5, the model takes into account the liquidity risk determinants within
both types of banks. In terms of macroeconomic variables, as can be seen from the results,
the inflation rate is negative and significant in all models for conventional banks. This is not
consistent with our hypothesis, H1 and the finding of Vodova (2011), which reports positive
link between inflation rate and liquidity risk. This can be explained by the fact that in an
inflationary environment, banks have to decrease their liquidity risk to protect the
depositors and to take the necessary precautions against the occurrence of a “bank run.”
This can also be explained by the fact that banks grant less financing during inflationary
environment. This would be expected since rise in inflation will lead to a decrease in the
profitability and on the values of collateral security deteriorate and; on top of that an
increase in the cost of bank, which later leads to increased liquidity risk. However, the
inflation rate does not seem to have any significant explanation for the evolution of the
liquidity risk indicator for Islamic banks. Consequently, our hypothesis, H1, is not
supported for Islamic banks, and this result seems to be contrary to that of Sulaiman et al.
(2013). Actually, Islamic banks based on Sharia have to keep a higher reserve of capital and
will increase the liquidity ratio to reduce their liquidity risk in case of inflationary
environment. Hence, the effect of the inflation rate had harmful effects only for the
conventional banks.
Next, the coefficient of the GDP growth variable is negative and significant through
all models for conventional banks, confirming our hypothesis, H2 and the findings of
IJLMA Dinger (2009) and Abdul-Rahman et al. (2018). This result implies that the economic
63,1 growth offers good business opportunities to banks to generate higher incomes where
they can provide better liquidity. In other words, the banks appear to build up their
liquidity buffers during economic downturn and draw them down in economic
expansions. This coefficient seems to have an important explanatory power for the
evolution of banking liquidity risk in conventional banks. However, this variable has
80 no relevant impact on liquidity risk for Islamic banks in all models. Hence, our
hypothesis, H2, is not supported for Islamic banks, and this result is contrary to that of
Sulaiman et al. (2013). This result can be explained by the fact that Islamic banks based
on Sharia capable of escaping shock thanks to their very principles and in the purpose
to generate more economic growth.
With regard to the link between financial crisis and liquidity risk, it is positive and
significant for conventional banks. This result can be explained by the fact that the
financial crisis causes surely an increase in toxic loans in conventional banks, which
prompted the majority of depositors to withdraw their funds, which thus led to an
inability to repay, and hence a lack of bank liquidity, in other words, a higher liquidity
risk. Thus, our hypothesis, H3, is confirmed and the result is in concordance with the
findings of Ben Saleh and Boujelbene (2018). Note that Islamic banks show positive
relationship between financial crisis and liquidity risk, though not significant. This
suggests that Islamic banks generally have higher capital and lower credit risk than
conventional banks leads to a low level of liquidity risk is associated to a more stable
banking system. Therefore, the effect of the financial crisis had harmful effects for the
conventional banks as compared to the Islamic counterparts. Thus, our hypothesis, H3, is
not confirmed but the result is in concordance with the findings of Ben Saleh and
Boujelbene (2018).
In terms of bank-specific variables, the NPL ratio (i.e. credit risk) affects positively and
significantly the liquidity risk by the two split sample adopted in all models The
explanation for the positive relation between liquidity and credit risk, based on the “Monti-
Klein framework and financial intermediation” theory, is that credit and liquidity risks are
related. For conventional banks, this finding implies that credit risk increases due to a large
number of bad debts, which leads to an increase in liquidity risk due to the majority of
depositors to withdraw their funds. For Islamic banks, the positive relationship between
credit risk and liquidity risk is explained by the fact that Islamic banks are generally highly
dependent on the real estate sector. If the borrowers fail to repay the financing, it will
directly contribute to the banks exposures to credit risk and therefore increase their liquidity
risk. However, this implies that banks are not able to answer the demand of the depositors.
In addition, Islamic banks are not allowed to use either a debt-based instrument to mitigate
credit risk or speculative methods, including swaps, futures and options. Since there is an
absence of Islamic money and interbank markets, credit risk becomes negatively related to
the liquidity of Islamic banks. However, credit risk is more unfavorable from the bank’s
liquidity position, indicating that liquidity and credit risk are closely related. Therefore, we
notice that Islamic or conventional banks need to start thinking of diversifying their
banking activities toward fee-based product offering. These results support our hypothesis,
H4 and are consistent with the results of Diamond and Rajan (2005), Iqbal (2012) and
Imbierowicz and Rauch (2014) arguing that there is a positive relationship between credit
and liquidity risks.
With regard to the CAR, the relative coefficient has remained negative and
significant in all models for Islamic banks. Thus, the “risk absorption out” hypothesis
finds support from the results. Likewise, for conventional banks, it is linked to liquidity
risk with negative sign but not significant only within the Model (2). This finding is in Liquidity risk
line with Chagwiza (2014), Abdul-Rahman et al. (2018) and Yaacob et al. (2016) and our determinants
hypothesis, H5, but not confirmed in the Model (2) for conventional banks, supporting
the fact that conventional banks maintain the role of capital buffer in minimizing risk,
banks which have a large capital means that they can use it to cover their due dates
and, therefore will have fewer difficulties. Furthermore, Berger and Bouwman (2009)
find that according to the risk absorption concept, capital has a positive impact on bank
81
liquidity, suggesting that higher capital permits more liquidity creation. Consequently,
appreciation of this variable seems to decrease liquidity risk. Regarding Islamic banks,
one can deduce that the best capitalized Islamic banks appear to more decrease
liquidity risk. Put differently, one might well deduce that with high-risk levels, Islamic
banks appear to be in need for a large capital amount to recover their due dates, will
have fewer difficulties, and, therefore reduce liquidity risk.
In terms of profitability, ROE is positively related to liquidity risk solely within
conventional banks’ sample in all models, not confirming our hypothesis, H6, and is
consistent with the findings of Effendi and Disman (2017). This result can be explained by
the fact that to gain a higher income, banks have to be involved in risk-taking activities that
indirectly increase their exposure to long term liquidity risk. With regard to Islamic banks,
ROE shows a negative and significant link with liquidity risk. Thus, our hypothesis, H6, is
confirmed and the result is in concordance with the findings of Ben Saleh and Boujelbene
(2018). This result then implies that the shareholders require higher returns for their
additional participations in the bank’s capital, where Islamic banks are able to carry out a
normal and short-term loaning activity. Moreover, Islamic banks are procyclical in nature
that is additional revenue from funding supported by a low default risk results in raised
profits where the profits will allow the banks to offer better liquidity and, therefore lower
liquidity risk.
Starting with the size of Islamic banks, the coefficient is positive and significant in Model
(2), confirming our hypothesis, H7, but is contrary with the finding obtained by Alzoubi
(2017). This result demonstrating that banks which are small in size are required to hold less
liquidity risk due to limited external sources of funding while large banks hold more
liquidity risk because of the increase in their indebtedness and they are able to arrange
funds from the inter-bank market and other sources under the “too big to fail” presumption.
Although Model (2) for conventional banks do not show significant results, our findings
consistently portray that size has a positive impact on liquidity risk, implying that
conventional banks refers to a poor market valuation for liquidity needs and hence increase
the risk (Akhtar et al., 2011). This result also suggests that large banks take excessive risks
by increasing their leverage under the “too big to fail” presumption, and therefore have more
NPLs, which means a less assets liquid and, therefore higher liquidity risk. Consequently,
our hypothesis, H7, is not confirmed but the result is in concordance with the findings of
Bunda and Desquilbet (2008) and Vodova (2011).
Finally, liquidity gap affects positively and significantly the liquidity risk in both
banking systems, demonstrating that an increase in liquidity gap increases liquidity
risk. This implies that the liquidity gap play an important role in providing liquidity to
banks. The positive and statistically significant relationship confirms our hypothesis,
H8. This result is among the most important findings of the study, given that we are the
first to consider it and test that liquidity gap is a determinant of liquidity risk.
Therefore, there is another indicator that determines liquidity risk of Islamic and
conventional banks.
IJLMA Conclusion
63,1 This study enables us to identify systematic and unsystematic liquidity risk
determinants within both types of banking systems using a panel data set of 76 banks
operating in the MENA region over the 2005–2015 period. Indeed, credit risk, ROE,
liquidity gap and CAR are the common liquidity risk determinants within both banking
systems. On the macroeconomic level, the results indicate that financial crisis, inflation
82 rate and economic growth are indicators that determine the liquidity risk of conventional
banks. However, this is not the case for Islamic banks. Therefore, the findings lead to the
conclusion that Islamic banks are more sensitive to bank-specific factors than
macroeconomic factors. These results can be explained by the Islamic law (prohibition of
payment or receipt of interest (Riba)), the inefficiency of Islamic money markets (the lack
of liquidity) and the lack of diversification (Islamic banks are generally highly dependent
on the real estate sector). As a result, this suggests that regulatory authorities should
focus more on risk management strategy and managerial performance. Therefore,
Islamic banks should manage this risk differently as conventional banks while
complying with Islamic Sharia.
Our study has several interesting implications. First, it provides guidelines to academic
researchers about the liquidity risk in Islamic and conventional banks. Actually, the results
lead to distinguish the main sources affecting liquidity risk within both types of banks.
Second, our results can be used by bankers’ policy decision-makers to improve and enhance
their consideration for liquidity risk management. More specifically this makes them aware
to manage liquidity risk differently between conventional and Islamic banks, since our
findings reveal different liquidity risk determinants. This is due to differences in the system
and returns because Islamic bank use profit-sharing while conventional bank use payment
of an interest rate. Actually, Islamic bank can be considered as a partnership but
conventional bank as customer-creditors-debtors. Third, our results provide guidelines to
practitioners after the recent economic and financial crisis. In practice, the results have a
significant impact on the economic and commercial. The fact that Islamic banks are based
on Islamic law, so not affected by macroeconomic factors, suggests that a well-functioning
of Islamic bank system contributes toward the economic development and also trying to
contribute their part to the betterment of the society. Conversely, conventional banks based
on interest focus more on diversification of their activities, risk management systems,
managerial performance, and measures to identify banks with potential impaired loans,
lower liquidity and possible financial instability. Therefore, Islamic finance stabilizes the
economies. Finally, bank executives should place greater emphasis on having essential
skills to identify and understand the liquidity risk determinants within both banking
systems and improve their management differently for each type of bank. Thus, it would be
useful to examine for future research other regions to generalize the empirical results.
Moreover, it may be worth elaborating on the study of liquidity risk determinants using
structural equation modeling.

Notes
1. Islamic banks involve a special structure that differs noticeably from the conventional banks.
The philosophy and the operations of Islamic banks are different from those of conventional
ones, which are presented in the Appendix A.
2. He estimated two measures of liquidity (liquid assets/total assets; total loans/total deposits), a
static panel method and a dynamic panel method.
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Appendix 1
Conventional bank
Principles Based on interest principle
Sometimes involved in foreign
exchange speculative dealing
Loans Using the principle of borrowing
money
They are offering loan for a fixed
reward, and three types of loans: short
term loans, long-term loans and
overdrafts
Liquidity Money and liquidity are based on
interests on borrowing from the any
market
Sale of debts exists
Risk Shifting risk when involved or
expected
Guaranteeing all its deposits.
Based on credit-worthiness of the
costumers
Capital The minimum capital requirement is
10.5% of risk-weighted assets under
the Basel III accord, and the debate is
still active on how much capital banks
should hold
Corporate governance Subject to a set of regulations: banking
supervision, financial reporting
standards and external audit
Liquidity risk
determinants
Islamic bank
Based on Shari’ah principle
Maximize profits subject to profit-loss
sharing system 87
Gharar and Maysir are forbidden
Using the principle of buying and
selling using mainly Murabaha and
Mudharabah contracts
They cannot charge interest on loans
but profit on investments. Islamic
banks can issue just interest free loans
(Qarz el Hasan) for any requirement but
they can do business by providing the
required asset to client
Money and liquidity are based on
Shari’ah-compliant for any transaction.
In fact, Islamic banks suffer from
limited access to Islamic money market
and intra-bank, that is why they must
have a very high liquidity and capital
ratios to cover potential difficulties
Large restrictions on sale of debts,
where Islamic banks cannot sell their
own debt using conventional securities
Bearing risks when involved in any
transaction
Guaranteeing only current account
deposits
Based on the viability of the projects
Islamic banks must have a 100%
capital reserve
To respect Shari’ah-compliance, Islamic
banks are governed by an additional Table A1.
internal governance mechanism which Islamic vs
is the Shariah supervisory board conventional banks
 88
63,1
IJLMA

Table A2.

Islamic and
liquidity risk
determinants in
the literature on

conventional banks
Summary review of
Authors Samples Determinants Methods Main results

Liquidity risk determinants in conventional banks

Berger and Virtually all U.S. banks Size Regression Capital has a positive relationship
Appendix 2

Bouwman (2009) from 1993 to 2003 Capital adequacy ratio analysis with liquidity creation for large
Bank risk banks and negative for small
Bank holding company status banks
Mergers and acquisitions
Local market competition
Local market economic
environment
Vodova (2011) Czech commercial banks Capital adequacy ratio Regression Capital adequacy, assets quality,
over the period from 2001 Assets quality analysis interest rates on loans and on
to 2009 Profitability interbank transaction are the
Size determinants of banking liquidity
Financial crisis Inflation rate, business cycle and
GDP growth financial crisis are also
Inflation rate determinants of banking liquidity
Interest rate on interbank .
transactions
Interest rate on loans
Difference between interest
rate on loans and interest rate
on deposits
Monetary policy interest rate
Unemployment rate
Munteanu (2012) 27 banks active in Capital adequacy ratio Linear multivariate Credit risk rate and capitalization
Romania over the period Assets quality regression model are the both common
2002–2010 Interbank funding determinants for the two liquidity
Funding cost measurement
Efficiency ratio The Z-score has also a significant
Z-score influence on bank liquidity in the
Interest rate robor crisis years
Credit risk rate
Inflation rate
(continued)
Authors Samples Determinants Methods Main results

GDP growth
Unemployment
Cucinelli (2013) 1,080 listed and non-listed CapitalizationSize OLS regression Size, capitalization,
Eurozone banks over the Bank specialization based on panel loan loss reserve ratio and bank
period 2006–2010 Loan loss reserve ratio data specialization can have an impact
GDP growth on liquidity risk management
Inflation rate
Financial crisis
Dummy listed banks
Horvath et al. (2014) Czech banks, which Capital Granger-causality Capital may be an important
mainly includes small Earnings volatility tests in a dynamic indicator of liquidity creation
banks from 2000 to 2010 Credit risk GMM panel
Z-score estimator
Non-performing loans framework
Size
Market share
Unemployment
Inflation
Imbierowicz and U.S. commercial banks Size Simultaneous- Credit and liquidity risks do not
Rauch (2014) during the period 1998 to Capital equation approach have an economically meaningful
2010 Profitability PVAR model reciprocal contemporaneous or
Efficiency ratio Multivariate time-lagged relationship
Loan growth logistic regression
Ratio of short-term-to-long- model
term deposits
Ratio of trading assets-to-total
assets
Net derivatives exposure
Real estate-to-total loans ratio
Agricultural-to-total loans
ratio
Commercial-to-total loans ratio
Individual-to-total loans ratio
(continued)

Table A2.
89
determinants
Liquidity risk
 90
63,1
IJLMA

Table A2.
Authors Samples Determinants Methods Main results

GDP growth
Savings ratio
Federal funds rate
Yield spread
Quarterly average leverage
Moussa (2015) 18 Tunisian banks over Performance Static and dynamic Performance, capital, operating
the period 2000–2010 % loans-to-total assets ratio panel expenses, GDP growth rate, and
Operating expenses inflation rate have a significant
Financial expenses impact on bank liquidity
Size .
Total deposit
Capital
Degree of conversion of
deposits in credits
GDP growth rate
Inflation rate
Roman and Sargu Banks operating in a Capital adequacy ratio OLS regression Capital adequacy ratio, assets
(2015) series of CEE countries Assets quality analysis quality and profitability have a
(Bulgaria, the Czech Management quality significantly influence on the
Republic, Hungary, Profitability overall liquidity of banks
Latvia, Lithuania, Poland, Size
Romania) over the period
2004–2011
Tran et al. (2016) U.S. banks from 1996 to Capital Vector Main determinants of liquidity
2013. Profitability autoregressive creation are capital and
Bank risk model profitability
Bank size
Productivity growth
Operating management
Market concentration
Stock market volatility
GDP growth
(continued)
Authors Samples Determinants Methods Main results

Ghenimi et al. (2017) 49 banks operating in the Profitability Simultaneous- There is a positive relationship
MENA region over the Capital adequacy ratio equation approach between credit and liquidity risks
period 2006–2013 Inflation rate PVAR model
GDP growth GMM
Credit risk
Size
Loan growth
Efficiency
Income diversity
Financial crisis
Liquidity risk determinants in Islamic banks
Sulaiman et al. (2013) 17 Islamic banks of Financing Dynamic panel Macroeconomic variables have a
Malaysia. Performance significant influence on the
Size behavior of Islamic banking in
Capital requirements managing liquidity
Short-term interest rate of The Islamic banking liquidity
three months interbank money management is affected by the
market bank specification factors
Money supply
Inflation rate
GDP Growth
Yaacob et al. (2016) 17 Islamic Banks in Capital adequacy ratio Unbalanced panel Capitalization, financing, GDP
Malaysia and based on Size data regression and inflation have a significant
secondary data covers a Profitability analysis impact on liquidity risk
period from 2000 until Non-performing financing
2013 Financing
GDP growth
Inflation rate
Alzoubi (2017) 42 Islamic banks from 15 Cash ratio Panel data Cash ratio, securities, bank size,
countries between 2007 Securities analysis, capital have a negative impact on
and 2014 Bank’s size Correlation matrix liquidity risk, while profitability
Squared value of a bank’s
(continued)

Table A2.
91
determinants
Liquidity risk
 92
63,1
IJLMA

Table A2.
Authors Samples Determinants Methods Main results

assets and bad financing have a positive

Profitability
Capital
Bad financing
Liquidity risk determinants in Islamic and conventional banks
Iqbal (2012) Conventional and Islamic Size
banks of Pakistan from Non-performing loan ratio
the period 2007–2010 Profitability
Capital adequacy ratio
Sukri and Islamic and conventional Credit risk
Waemustafa (2016) banks from 2000 to 2010 Leverage ratio
Financing concentration
Regulatory capital
Financing loss provisions
Financing
Riskweighted assets
Financing by Shari’ah concept
Debt-to-equity ratio
Solvency ratio
Company’s leverage
Management efficiency
Profitability
Size
GDP growth
Inflation
Money supply (M3)
Output gap
Yield curve
Islamic interbank rate
Effendi and Disman Capital
(2017) Financial expansion
impact
Pearsons’ Capital adequacy ratio,
correlation profitability, size and non-
analysis, performing loan ratio are the most
regression analysis determinants of liquidity risk in
both models
Multivariate Islamic banks maintain higher
regression analysis liquidity compared to
conventional banks
The 4 out of 14 bank-specific
factors and one macroeconomic
factor significantly influence the
liquidity risk of Islamic bank
whereas conventional banks show
that 5 out of 13 bank-specific
factors are significant to liquidity
risk
Quantitative Variables that affect the liquidity
techniques using risk in Islamic banks are the
(continued)
Authors Samples Determinants Methods Main results

20 Islamic banks and 12 Quality financing panel data capital, financial expansion,
conventional banks from Net income margin regression quality financing and credit risk
2009 to 2015 Credit risk Financial expansion, quality
Profitability financing, credit risk and
Size profitability are the mostly
determinants of liquidity risk in
conventional banks
Abdul-Rahman et al. 27 conventional and 17 Real estate financing Regression Short- and long-term liquidity
(2018) Islamic banks from 1994 Financing concentration analysis, risks are explained by number of
to 2014 Short-term financing stability generalized least real estate financing and short-
Medium-term financing square term FS stability in Islamic banks.
stability Long-term liquidity risk is
Size explained by short-term FS
Capital adequacy ratio stability and financing
Profitability specialization in conventional
Non-performing financing banks
GDP growth The liquidity risk behavior, to
Inflation some extent, differs between both
types of banks
Ben Saleh and 88 conventional banks Capital Simultaneous Size, profitability and financial
Boujelbene (2018) and 42 Islamic banks from Z score equation model crisis have a strong influence on
2005 to 2013 Size banking liquidity
Loan
Profitability
Net interest margin
GDP growth
Inflation rate
Financial crisis
Political crisis

Table A2.
93
determinants
Liquidity risk
IJLMA Appendix 3
63,1
Country Islamic banks Conventional banks

Saudi Al Rajhi Bank Riyad bank

Arabia Bank AlBilad Samba Financial Group
94 National Commercial Bank
Saudi British Fransi
Banque Saudi Fransi
Saudi Hollandi Bank
Saudi Investment Bank
Bank AlJazira
Bahrain Bahrain Islamic bank Bank Bahrain Kuwait
Al Baraka Banking Group BSC National Bank Bahrain
Kuwait Finance House Ahli United Bank B, S, C,
Shamil Bank of Bahrain B.S.C. Arab Banking Corporation BSC
Gulf International Bank BSC
Kuwait Kuwait Finance House National Bank of Kuwait S, A, K,
Kuwait International Bank Gulf Bank KSC (The)
Boubyan Bank KSC Burgan Bank SAK
Al Ahli bank of Kuwait (KSC)
Ahli United Bank KSC
Jordan Jordan Dubai Islamic Bank Arab Bank Group
Arab Bank Plc
Housing Bank for Trade and Finance
Jordan Ahli Bank Plc
Bank of Jordan Plc
Cairo Amman Bank
Capital Bank of Jordan
Jordan Commercial Bank
Arab Banking Corporation
Yemen Tadhamon International Islamic Bank International Bank of Yemen YSC
Shamil bank National Bank of Yemen
Yemen Commercial Bank
Yemen Kuwait Bank for Trade and Investment
Qatar Qatar Islamic Bank SAQ Qatar National Bank
FIRST FINANCE COMPANY Commercial Bank of Qatar (The) QSC
Masraf Al Rayan (Q.S.C.) Doha Bank
Qatar International Islamic Bank International Bank of Qatar QSC
Ahli Bank QSC
UAE Amlak Finance Emirates NBD PJSC
Dubai Islamic Bank PJSC National Bank of Abu Dhabi
Abu Dhabi Islamic Bank Abu Dhabi Commercial Bank
Emirates Islamic Bank PJSC Mashreq Bank CFP
Nour Islamic Bank Bank of Sharjah
Sharjah Islamic Bank Commercial Bank of Dubai CFP
Tamweel PJSC First Gulf Bank
National Bank of Fujairah
Invest Bank PSC
National Bank of Ras Al Khaimah (CFP) (The)
RAKBANK
Union National Bank
United Arab Bank PJSC
Table A3. (continued)
List of banks
 Liquidity risk
Country Islamic banks Conventional banks
determinants
Egypt Faisal Islamic Bank of Egypt
Turkey Kuveyt Turk Katilim Bankasi TC Ziraat Bankasi AS
ASKoweït participation turque Banque
Inc
Turk Bankasi AS Finans Katilim
Albaraka Turk Participation 95
BankAlbaraka Turk Katilim Bankasi
AS
Total of 27 49
banks Table A3.

Corresponding author
Ameni Ghenimi can be contacted at: amenighenimi@yahoo.fr

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