The Impact of Liquidity Risk on the Financial Performance of Islamic

Banking Industry in Pakistan

Sanaullah Ansari

Shaheed Zulfikar Ali Bhutto Institute of Science and Technology (SZABIST), Islamabad, Pakistan

Background of the study

• History of Islamic Banking

Islamic Banking is based on Riba Free system and was started in 1940s in Malaysia and 1950s in Pakistan but did not succeed. The first Islamic Bank “The Mit Ghamr Saving Bank” was established in Egypt in 1963. After that, this idea and concept spread in many of the Muslim countries as well as non-Muslim countries.

• Islamic Banking in Pakistan

The experience of 1950s was not successful and almost dropped. This was again experienced in 1980 when State Bank of Pakistan made changes in Banking Rules in accordance with Sharia’h and tried to establish Islamic Banking System as parallel to Conventional Banking System.

Background of the study

Present Islamic Banks in Pakistan

• Al-Baraka Islamic Bank Pakistan (1991)

• Meezan Bank Limited (2002)

• Bank Islami Pakistan Limited (2003)

• Dubai Islamic Bank Pakistan Limited (2005)

• Dawood Islamic Bank (Burj Bank Limited) (2006)

Objective of the study

The main objective of this study is to determine the factors which significantly influence the liquidity risk management

and its impact on the financial performance of Islamic banking industry

in Pakistan.

Literature Review

• Ahmad, H. and Khan, Tariqullah (2007) • Akkizidis, I and Khandelwal, S. K. (2008) • Askari et al (2009) • Ayub, M. (2007) • Chapra, M. U. (2008) • Hassan, A. (2009) • Ismail, R. (2008) • Kahf, M. (2000) • Siddiquie, A. (2008) • Karim, A. A. (2006) • Zhu, H. (2001)

Sample

The quarterly data of 5 Islamic banks in Pakistan has been obtained from their financial statements from the

period of 2005 to 2011.

Method

Capital / Total Assets have been used as proxy to measure the liquidity risk of Islamic banking industry, and following has been used as independent variables.

• Debt Equity Ratio (D/E)

• Non-Performing Loans Ratio (NPL)

• Earning on Assets (EOA)

• Capital Adequacy Ratio (CAR)

Major Findings

• Descriptive Statistics

Descriptive statistics show the mean and standard deviation of the results. Liquidity ratio has been used as dependent variable and its mean is compared with the means of other independent variables. The mean of Debt/Equity Ratio and Capital Adequacy ratio is greater than the mean of Liquidity Risk which means that that these 2 ratios are negatively impacting liquidity risk. The mean of Earning on Assets and Non-Performing Loans Ratio is less than the mean of Liquidity Risk. It means that that these 2 ratios are positively impacting Liquidity Risk.

Major Findings

• Correlation

Correlation among all independent variables is not more than 0.60 which means that all independent variables have no positive and significant relationship with each other which could impact liquidity risk. It shows that all independent variables have their independent impacts on liquidity risk management by Islamic banking industry in Pakistan.

Major Findings • Regression

The value of adjusted R-square shows that about 64.3 percent change in liquidity risk can be observed with independent variables under this study. The relationship of debt equity ratio and capital adequacy ratio is found to have significant and negative relationship with liquidity risk at 1% and 10% level respectively. The earning on assets ratio established the positive and significant relationship with liquidity risk at 5% significance level. The relationship of NPLs ratio with liquidity risk is statistically insignificant.

Conclusion • It has been concluded that debt equity ratio and

capital adequacy ratio has significant and negative relation with liquidity risk which means that these two ratios are not much impacting liquidity risk management by Islamic banking industry. Whereas, earning on assets ratio has very strong and positive relationship with liquidity risk which shows that this ratio has a major impact on liquidity risk management. Similarly, non-performing loans ratio has no relationship with liquidity risk which means that non-performing loans are not having an impact on liquidity risk management by Islamic banking industry in Pakistan.

Conclusion

• Therefore, In the light of the results, it is suggested that Islamic banks should increase their equity to reduce their liquidity risk. Secondly, Islamic banks should maintain proper relationship between assets and the capital of respective firm to reduce the liquidity risk. Islamic banks should also diversify their investments to maintain their financial performance and reduce the liquidity risk. By these taking these steps, Islamic banking industry can overcome the problem of liquidity risk and can improve its financial performance in future.

Thanks

Questions are Welcome