LIQUIDITY RISK & LIQUIDITY MANAGEMENT

LIQUIDITY RISK & LIQUIDITY MANAGEMENT
in Islamic banks
Baking Theory—Why banks exist?
Liquidity Issues in Islamic banks
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Sources of liquidity risk in IBs
How it is managed and the consequences
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What is being done and further developments
Banking Theory—Why banks exist?
Banks as providers of liquidity insurance to depositors and clients
Rationale for deposit taking and lending by same institution (bank)à Theory of bank intermediation
The Nature of Banking Firm Brings in Liquidity Risk
Islamic Banks are likely to be more stable
They have profit sharing on both the liability side and asset side
In practice, Islamic Banks have fixed income assets but have profit sharing on liability side.
The IBs therefore, are still more stable than conventional banks.
Solvent
Asset tied finance
Liquidity crunch can be a real problem

While majority of Islamic banks experience excess liquidity
Some have also faced liquidity crisis
Many different risks culminate in liquidity risk
Example of Financial Crisis in Turkey 2000-2001
Islamic financial institutions there faced sever liquidity problems
One Islamic institution Ihlas Finans was closed during the crisis
LIQUIDITY RISK: Definition
Risk of Funding [at appropriate maturities and rates]

Risk of Liquidating Assets [in time at reasonable prices]
LIQUIDITY RISK: Sources
Incorrect judgment and complacency
Unanticipated change in cost of capital
Abnormal behavior of financial markets
Range of assumptions used
Risk activation by secondary sources
Break down of payments system
Macroeconomic imbalances
Contractual forms
Financial Infrastructure deficiency
Liquidity Surplus Problem
Excess Liquidity is the current norm with Islamic banks
Where to park for short-term?
Use of most Islamic modes requires longer tenor investment, murabaha leads to illiquidity (liquidity risk). This induces banks to hold more liquidity, but this is costly. This leads to very short-term murabahaà low earnings.
Excess liquidity à Use of commodity murabaha
Absence of LoLR facility is also a reason
LMC’s Short Term Sukuk Program
Repackages longer instruments into monthly maturity certificates
–Guaranteed monthly entry and exit dates
–Intra-month entry and exit also available (no penalties)
–Flexibility of investment amounts
–Fully secured by underlying Sukuk portfolio
–Monthly returns