Investigating the Relationship between Liquidity Risk, Asset Quality, and Financing in Islamic and Conventional Banking Systems, Using PCSE and FGLS Models

Objective: Every banking system, whether Islamic or conventional, faces a wide range of risks, among which liquidity risk seems to be one of the most substantial. It is also noticeable that liquidity management in the Islamic banking is more complicated than in the conventional banking because the traditional instruments used in liquidity management are based on interest and their use in the Islamic banking system is not permissible. However, it has been proclaimed that, especially after the 2008 financial crisis, in terms of liquidity risk management, the Islamic banking system has acted more persuasive than the conventional banking system. Method: Applying PCSE and FGLS panels methods for 72 Islamic, and 51 conventional banks, this research has examined the relationship between liquidity risk, asset quality, and financing in the two banking systems during the period 2011-2016. Results: The results show that, in Islamic banking, while liquidity risk has a significant positive relationship with financing, the former indicates a negative relationship with asset quality. However, in conventional banking, the effect of financing and the size of liquidity risk is positive and significant, but the effect of asset quality is not significant