Liquidity Problems in Islamic Banks; Reasons, Impacts and Solutions

Abstract

The purpose of the research is to study the types of liquidity problems in Islamic banks, to analyse the causes of liquidity problems along with their impacts on Islamic banking industry with the objective of finding solutions to the liquidity problems of Islamic banking industry (IBI). The study design was based on primary research conducted through development of a questionnaire along with the interviews of Shariah advisors. The questionnaire was distributed among the Islamic bankers engaged in liquidity management process working at senior and middle management level. The study initially examined liquidity problems in Islamic banks along with the mitigation techniques employed by the Islamic banking industry to control them. Thereafter, the study highlighted shortfalls in bank practices or non availability of Shariah compliant mitigation tools. Finally, the study discussed Shariah compliant mitigation techniques to tackle different kinds of liquidity problems in Islamic banks and suggested solutions to the problems. The study revealed that liquidity problem in IBI consists of two opposite facets i.e. surplus liquidity and liquidity crunch and most of the Islamic banks faced both kinds of liquidity problem at different times. The study further elaborated key factors affecting liquidity position of Islamic banking industry. The study also found that the role of Shariah advisors is all the more important in IBI. The results of the research divulge that Islamic banks can solve liquidity problem through issuance of sukuk bonds against their long term portfolio as well as through the development of common Musharika pool to be regulated by Central bank. The paper may be of value to the global IBI, central banks as well as conventional banking industry, academic institutions along with researchers for additional research.