ESSAYS ON ISLAMIC BANKING AND SUKUK MARKETS: LIQUIDITY CREATION, LIQUIDITY AND CREDIT RISK, CAPITAL AND ECONOMIC GROWTH NEXUS

Abstract

Islamic banks emerged in the 1970s as an alternative financial player, and since then, they have demonstrated high performance in many countries in the world. In addition to their own unique normative nature, Islamic banks operate within the existing financial and economic system, and, therefore, they face similar risks, including liquidity (LR) and credit risks (CR). As a primary function of the banking sector, banks play a critical function in fostering the growth of the economy by liquidity creation (LC). The growth of the economy through total capital accumulation (TCA) and total factor productivity (TFP) in an embedded sense works towards the fulfilment of the ‘good society’, or the ihsani society (equal society) aims of the Islamic moral economy.
The first essay examines the relationship between LR, CR and capital and their impact on bank stability using a dataset of 1,198 banks spanning 39 countries from 2005 to 2019. The findings suggest that banks with higher capital ratios are less exposed to LR, while higher exposure to LR increases banks’ CR. IBs are found to be less exposed to CR compared to CBs, and banks located in Muslim- majority countries are less prone to liquidity and CR. Furthermore, the findings suggest that banks operating in oil-rich countries are more capitalized and exposed to higher levels of CR, while banks operating in countries with high development and governance qualities are more capitalized and are exposed to lower levels of CR. Moreover, larger banks are more capitalized and exposed to higher CR than smaller banks. The results also suggest that higher geo-political risk results in higher liquidity and CR, while liquidity, CR and capital are necessary determinants of banks' stability. In addition, liquidity and CR increase the bank default risk, whereas higher capitalization increases the bank’s stability. Lastly, increased oil prices, stronger financial development and higher governance quality positively impact bank stability.
The second essay explores the impact of sukuk issuance on the LC in Islamic banks compared to the conventional banks using a dataset of 612 banks in 16 sukuk issuing countries with dual banking systems covering the period between 2000 and 2020. The study decomposes sukuk issuance into corporate and sovereign sukuk to explore their impact on the LC. The study also utilises sub-samples, including examining the association between LC and sukuk issued in Malaysia and Gulf Cooperation Council (GCC) countries. Using random effects econometrics modelling, the findings suggest the crowding-out effect of sukuk issuance on banks’ LC levels and that sovereign sukuk has a highly diminishing impact on LC in banks. Regarding Islamic banks, the findings suggest that sovereign sukuk issuance in countries crowds out the total LC in banks, where on-balance sheet LC is insignificant. Furthermore, the crowding-out impact is highly significant in high-income countries, and corporate sukuk issuance diminishes the LC more in low-income countries. Lastly, the findings show that in Malaysia, the crowding-out impact is severe, while in GCC, the corporate Sukuk promotes the LC in their banks.
Essay three aims to examine the impact of LC in IBs on the sources of economic growth in the form of the growth in TCA and TFP through a dataset consisting of annual bank-level data for LC from 873 banks (with 130 IBs) and data on the sources of economic growth for 25 countries spanning from 2000 to 2019. Using the ordinary least squares method, the paper found that LC in banks is not a significant determinant of economic growth sources. However, the findings regarding the subsamples suggest that LC in IBs and CBs have a distinctive impact on the sources of economic growth. The results further show that liquidity created from IBs promotes real economic growth through a positive and significant impact on TCA and total TFP. On the other hand, the liquidity created in CBs negatively diminishes TCA but has no significant effect on the total TFP.
This research contributes to the literature on LC, LR management, capital, sukuk and source of economic growth nexus by examining the three essays through Islamic and conventional bank samples.