Liquidity crisis: Are Islamic banking institutions more resilient?

Abstract

The importance of liquidity risk and the threat of ensuing bank-run cannot be overemphasized. The peculiar structure of Islamic banks and their call to the faith of the customers pose interesting questions regarding their behavior during a liquidity crisis and calls for detailed empirical study. Using a natural experiment from Pakistan we attempt to fill this gap and decipher the differential behavior of Islamic and conventional banking institutions during the episodes of liquidity crunch. Our results show that, Islamic banking branches are less prone to the risk of withdrawal during the bouts of liquidity stress and this effect remains there after introducing an array of controls. Moreover, the Islamic operations of same bank tend to attract more deposits than their conventional operations implying that religious branding might have a role in this phenomenon. The results further highlight that the Islamic banking institutions are more likely to grant new loans during episodes of liquidity crisis and that at occasions their lending decisions might be less sensitive to changes in deposits. The results suggest that, greater financial inclusion of faith based groups through Islamic banking, for example, may not only increase their economic well being but may also bring in stability in the financial system.

Citation

Zaheer, S.; Farooq, M. Liquidity crisis: Are Islamic banking institutions more resilient? Presented at Joint RES-SPR Conference on “Macroeconomic Challenges FacingLow-Income Countries,” Washington, DC, January 30–31, 2014. International Monetary Fund, Washington DC, USA (2014) ii + 40 pp.

Liquidity crisis: Are Islamic banking institutions more resilient?

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