Factors Affecting Liquidity of Islamic Banks in Saudi Arabia

Transcription

1. Factors Affecting Liquidity of Islamic Banks …….., Diyaeldin A. Abdelmagid Factors Affecting Liquidity of Islamic Banks in Saudi Arabia Dr. Diyaeldin A. Abdelmagid * Abstract: The main purpose of this study is to investigate factors affecting liquidity of Islamic banks in Saudi Arabia. The data covered the period from 2007-2017 for the four Islamic banks operating in Saudi Arabia. Internal and external factors were analyzed by using panel fixed and random effect regression estimates. Internal factors include profitability, size, capital adequacy and deposits. External factors include GDP, unemployment rate, inflation, monetary policy, and international crisis. Results of panel data regression analysis showed that Islamic banks’ liquidity is negatively related to deposit ratio and murabaha profit margin rate are positively related to capital adequacy of Islamic banks. The relation between profitability and interbank transactions and Islamic bank liquidity is ambiguous. The study has also found that bank size, the growth rate of GDP unemployment, and the inflation rate have no statistically significant effect on the liquidity of Saudi Islamic banks. Thus, Islamic banks in Saudi Arabia should not only be concerned with internal factors, policies, and procedures, but they must consider both the internal and the external environment together in developing their strategies to efficiently manage their liquidity position. Keywords: Islamic banks, Islamic banks in Saudi Arabia, liquidity measurement, determinants of liquidity. * Saudi Arabia, Shaqra University. 9
2. ‫‪Banking & Financial Studies Issue No. 36 : July 2020‬‬ ‫‪10‬‬ ‫املستخلص‪:‬‬ ‫هدفت هذه الدرادة إىل التعرف عؾى العوامل املؤثرة عؾى دقولة املصارف اإلدالمقة‬ ‫العامؾة باملؿؾؽة العربقة السععويوة خعالا الػع ة ‪7002-7002‬م‪ .‬ادعتددمت الدرادعة‬ ‫حتؾقؾفا لؾعوامل الداخؾقة واخلارجقعة املعؤثرة عؾعى دعقولة املصعارف اإلدعالمقةب دعؾوبي‬ ‫األثر الثابت والعشوائي لتؼدور معايلة االحندار اخلطي املتععدي ليقانعاا السؾسعؾة الزمـقعة‬ ‫املؼطعقة‪ .‬تضؿـت العوامل الداخؾقعة الريقعةب امجعمب كػعاأة ر س املعاا والويائع ‪ .‬معا‬ ‫العوامل اخلارجقة فؼد اذتؿؾت عؾى متغرياا االقتصاي الؽؾي (الـعات الؼعومي اإللعاليب‬ ‫معدا اليطالةب والتضدم)ب إضافة لؾسقادة الـؼدوة واألزماا العاملقة‪ .‬توصعؾت الدرادعة إىل‬ ‫ن العالقة بني كلٍ من نسية الويائ وهامش ربح املراية م دعقولة املصعارف اإلدعالمقة‬ ‫هي عالقة عؽسقة‪ .‬كؿا ظفرا الدرادة ن العالقة بني كل معن الريقعة ومععدا التعامعل‬ ‫بني اليـوك م السقولة هي عالقة وشوبفا الغؿوض‪ .‬معا كػعاأة ر س املعاا فتعؤثر إاابقعا‬ ‫عؾى دقولة تؾك املصارف‪ .‬كؿا ظفرا الدرادة نه ال توجد عالقعة ااا ياللعة إحصعائقة‬ ‫لؽل من حجم املصرفب معدا منو الـات احملؾي اإللاليب معدا اليطالة ومعدا التضدم‬ ‫م دقولة املصارف اإلدالمقة‪ .‬لذلك اع عؾعى املصعارف اإلدعالمقة املؿؾؽعة العربقعة‬ ‫السعويوةب وهي تطور اد اتقجقاا متتني مركزها من ناحقة السقولةب و ال تؼصر اهتؿامفا‬ ‫عؾى املتغرياا الداخؾقة واخلارجقة معا و املتعؾؼة بالسقاداا واإلجراأاا فؼط وإمنعا تفعتم‬ ‫وضا مبتغرياا السقادة الـؼدوة‪.‬‬ ‫الكلمات املفتاحية‪ :‬املصارف اإلدالمقةب املصارف اإلدالمقة املؿؾؽة العربقة السعويوةب‬ ‫مؼاوقس السقولةب حمدياا السقولة‪.‬‬ ‫‪1- Introduction:‬‬ ‫‪Banks act as liquidity providers and financial intermediaries in a‬‬ ‫‪financial system. Banks could accomplish that by mobilizing funds‬‬
3. Factors Affecting Liquidity of Islamic Banks …….., Diyaeldin A. Abdelmagid 11 from the surplus units (depositors) and making use of the funds for financing the deficit units (borrowers). Therefore, banks are expected to maintain adequate liquidity in order to perform their daily obligations efficiently. They must also ensure sufficient liquidity in order to be able to fund an increase in assets. (Sekoni, A., 2015) Banks could use three practices to maintain adequate liquidity and to insure against liquidity crisis: The first practice is to hold a buffer of liquid assets on the asset side, a large enough buffer reduces the probability of adverse effects that liquidity demand can threaten the viability of banks. The second practice is to co-insure in the interbank market. According to this practice, banks could borrow from each other in case of liquidity demand. In case of a system-wide shortage of liquidity, banks could rely on the central bank as a lender of last resort to provide emergency liquidity assistance. (Aspachs, O., E. Nier and M. Tiesset, 2005) Conventional banks have no problem in using any of these three practices. Islamic banks, however, have many restrictions imposed on them related to their special nature. Islamic banks cannot use or deal in interest. In addition, Islamic banks can only invest in “Shariah” compliant instruments. This situation might force Islamic banks to hold higher levels of cash assets and renouncing many profitable investment opportunities in order to reduce their liquidity risks. (Alzoubi, T. 2017)
4. Banking & Financial Studies Issue No. 36 : July 2020 12 In 2008, the world banking system suffered a financial crisis worse than any earlier crises. This global crisis brought to light that liquidity risk management in banks plays a vital role in avoiding failure of banking systems and that the banks over the world will have to change their current practices to maintain adequate liquidity. (Turner, A. 2009) In response to the global financial crisis, the Basel Committee on Bank Supervision (BCBS) issued a new international regulatory framework, known as Basel III. In addition to strengthening the existing bank capital rules, Basel III has design, for the first time, a global framework for liquidity regulation. ( Keister, T., & Bech, M. L. 2012) Since that time, a considerable amount of literature has been published on the determinant of conventional banks' liquidity. Unlike conventional literature, there are limited empirical studies devoted to the determinant of Islamic banks' liquidity. Moreover, previous researches focusing on Islamic banks within the same country, stress different conclusions. This study will enrich the literature on this topic by considering the Saudi Islamic bank and adopt a panel method. 1.1 Statement of the Problem: Islamic bank faces difficulties in managing their short-term liquidity fluctuations. The self-insurance conduct them to the keep higher level of liquidity which can be a mandatory choice in a context of lack of availability of Sharia-compliant high-quality liquid assets, lack of active secondary market trading and insufficient tools
5. Factors Affecting Liquidity of Islamic Banks …….., Diyaeldin A. Abdelmagid 13 available to monetary authorities for providing liquidity support to Islamic banks. Thus, the risk facing Islamic bank are either magnified and/or difficult to mitigate, because of deficiencies and rigidities infrastructure in institutions and instruments (Habib, 2011). Theoretically, bank should hold sufficient liquidity in order to insure against liquidity risk. In this respect, Islamic bank should strengthen its risk management practices. Nevertheless, Ismal (2010) notes that the liquidity management of Islamic bank is less-than-ideal. Ramzan and Zafar (2014) recommend that Islamic banks deploy additional efforts in their liquidity management. Therefore, it is crucial to investigate the determinants of Islamic banks' liquidity in order to improve the liquidity risk management especially along with the limited empirical research devoted to this topic. 1.2 Objective of the Study: In the context of the problems, the general objective of this study is to empirically identify factors that affect Islamic banks' liquidity over the period 2007-2017 for a panel of four Islamic banks from Saudi Arabia 1.3 Significance of the Study This study is expected to provide empirical evidence on internal and external determinants of Saudi Islamic banks’ liquidity and greatly contribute to the existing knowledge in the area of this title in the context of Saudi Arabia. Its findings are highly important for Islamic banks and central banks.
6. Banking & Financial Studies Issue No. 36 : July 2020 14 2- Literature Review: 2.1 Liquidity: Concepts and Definitions: There are three main notions of liquidity, central bank liquidity, funding liquidity, and market liquidity (Nikolaou, K. 2009). The central bank liquidity consists of deposits of banks at the central bank that held to meet reserve requirements and to achieve a final settlement of all financial transactions in the payments system. Banks can borrow and lend these funds in the interbank market; however, the only source of these funds is the central bank (Cecchetti, S. G., & Disyatat, P. 2010). The term funding liquidity is relevant for the ability of banks to perform their intermediation functions. International Monetary Fund (IMF) define funding liquidity as the ability of solvent institutions to make agreed-upon payments in a timely fashion (Nikolaou, K. 2009). The third notion," market liquidity," refers to the ability to undertake transactions in such a way as to adjust portfolios and risk profiles without disturbing underlying prices. (Crockett, A. 2008). According to the Bank for International Settlements, liquidity is: “the ability of a bank to fund increases in assets and meet obligations as they come due, without incurring unacceptable losses.” (BIS, 2008). Liquidity at a bank can be defined as a measure of its ability to readily find the cash it may need to meet demands upon it. (Elliott, D. J. 2014). An asset's liquidity can be used to describe how quickly,
7. Factors Affecting Liquidity of Islamic Banks …….., Diyaeldin A. Abdelmagid 15 easily, and costly it is to convert that asset into cash (Berger, A. N., & Bouwman, C. H. 2009). 2.2 Liquidity Measurements: Liquidity plays a crucial role in many empirical studies, so it is vital that measuring it accurately. There are three approaches to measure liquidity, liquidity coverage ratio, liquidity gap, and liquidity ratios. Liquidity coverage ratio (LCR) is a vital part of the global framework liquidity regulation introduced by Basel III, which requires banks to hold a sufficient stock of highly liquid assets to survive 30 days of market stress. (Keister, T., & Bech, M. L. 2012). The LCR is calculated by dividing the bank's level of highquality liquid assets by the projected cash claims over the next 30 days. Banks will be required to maintain LCR's of 100% or more, that is, to have sources of cash more than sufficient to cover their expected outflows over the assumed 30-day crisis period. To be aligned with the item in balance sheet for Islamic Banks, Islamic Financial Services Board issued guidance note on quantitative measures for Liquidity Risk Management in Institutions Offering Islamic Financial. Services. (IFSB, 2014). According to IFSB 2014, the objective of the LCR is to ensure Islamic Banking to withstand the short-term liquidity shocks. To meet
8. 16 Banking & Financial Studies Issue No. 36 : July 2020 this requirement, Islamic banking should ensure have an adequate stock of unencumbered high quality liquid assets (HQLA) that can be converted easily and immediately into cash in order to meet its liquidity needs for a 30-calendar-day period under a liquidity stress scenario. This is based on the assumption that, if the requirement is met, the Islamic banks could survive for the 30 days of the given stress scenario. The formula as follow: Liquidity gaps are differences between the outstanding balances of assets and liabilities, or between their changes over time. Gaps are calculated as algebraic differences between assets and liabilities. Therefore, at any date, a definite gap between assets and liabilities is equivalent to a deficit, and vice versa. ( Bessis, J. 2011). The liquidity gap approach is confusing because there is no standard method to measure bank liquidity. (Ahmad, F., & Rasool, N. 2017). Liquidity ratios are various financial statements ratios that should identify the liquidity position. Vodova (2011) provides four financial statements ratios used to measure a banks' liquidity (Vodova, P. 2011). Following the four different liquidity ratios: L1= L2= The liquidity ratio L1 and L2 provide information about the bank's ability to absorb liquidity shocks. The higher the value of L1,
9. Factors Affecting Liquidity of Islamic Banks …….., Diyaeldin A. Abdelmagid 17 the higher the absorption capacity of liquidity shocks. The higher is the value of L2, the higher is the capacity to absorb liquidity shock. L3= L4= The liquidity ratio L3and L4 capture the changing nature of loans demands and the bank's ability to gather deposits and other assets. L3 indicates the proportion of the bank's assets being tied up in loans. The higher the value of L3, the less liquid the bank is. The higher the value of L4, the less liquid the bank is. The restrictions placed on Islamic banks make liquidity measurement and management a more difficult task. Islamic banks cannot invest in short-term financial instruments such as treasury bills, as they carry interest income which is forbidden in Islam. They also cannot borrow from other banks or financial institutions, because that option requires paying interest on the loans which is also forbidden for Islamic banks. Even the option of taking loans from central banks is problematic, since it will require paying interest on these loans. Gafrej and Abbes (2017) provide two financial statements ratios used to measure an Islamic banks' liquidity, which are the ratios of liquid assets to total assets and liquid assets to deposits and short term funding. (Gafrej, O. & Abbes, M. B. 2017) The Liquid Assets to Total Assets Ratio articulates the ability of banks to absorb the liquidity shock. The high liquidity ratio indicates that bank holds more liquid assets in their balance sheet and can
10. Banking & Financial Studies Issue No. 36 : July 2020 18 absorb the excessive withdrawal of money. The liquid assets is measured as follows: The Liquid Assets to Total Assets = * 100 The Liquid Assets to Deposits Short Term Funding ratio gives a picture of the liquidity position and articulates the ability of banks to pay its depositors. Higher liquid assets /deposits and short term funding indicates that the bank can pay its shorter maturity obligations. The liquid assets to Dep & ST Funding ratio is measured as follows: The Liquid Assets to Deposits Short Term Funding = Liquidity ratios are still in common use because of the availability of data that enable to calculate them and it is easy to interpret their values. (Vodova, P. 2011) 2.3 Empirical Studies: A number of studies have empirically looked at the various determinants of conventional bank’s liquidity. These studies suggest that conventional bank liquidity is a function of internal and external factors. Internal factors include bank specific determinants of liquidity whereas external factors are factors that influence bank liquidity but are not under the control of bank management.
11. Factors Affecting Liquidity of Islamic Banks …….., Diyaeldin A. Abdelmagid 19 Internal factors affecting liquidity of conventional banks includes: profitability, bank size, cost of funding, capital adequacy, deposits, non- performing loans, spreads and ownership. External factors affecting liquidity of conventional banks includes: gross domestic product, monetary policy, interest rate, interbank funding, unemployment rate, inflation rate and crisis Table 1 shows the results of selected empirical studies on the above mentioned topic.
13. Factors Affecting Liquidity of Islamic Banks …….., Diyaeldin9A. Abdelmagid 20 Factors Affecting Liquidity of Islamic Banks …….., Diyaeldin A. Abdelmagid Table 1: List of Selected Empirical Studies Results Author Country Nigeria Namibia Positive Significance Capital adequacy and gross domestic product Return on equity, Gross domestic product Nepal Capital adequacy Singh, A., & Sharma, A. K. (2016) Melese, N. (2015) Moussa, M. A. B. (2015) India Deposits, profitability, capital adequacy and inflation Bank size Growth rate of GDP Mashamba, T. (2014) Zimbabwe Vodová, P. (2013) Hungary Ferrouhi, E. M., & Lehadiri, A. (2013). Morocco Munteanu, I. (2012) Romania Vodova, P. (2011) Czech Ahmad, F., & Rasool, N. (2017) Edem, D. B. (2017) Sheefeni, J. P., & Nyambe, J. M. (2016) Gautam, R. (2016) Pakistan Ethiopia Tunisia Bank size and non-performing loans Capital adequacy, interest rate on loans and bank profitability bank’s size, share of own bank’s capital of the bank's total assets, external funding to total liabilities, monetary aggregate M3, foreign assets, foreign direct investment Credit risk rate and cost to income ratio Capital adequacy, interest rates on loans, Results Negative significance Non- performing loans and bank size Loan to deposit ratio - insignificant Profitability and inflation Monetary policy rate and inflation Non-performing loans and profitability Bank size and GDP Bank size, inflation and GDP growth rate Cost of funding and unemployment Capital adequacy and profitability Profitability, capital adequacy and Inflation rate Spreads and capital adequacy ratio Nonperforming loan and loan growth size, total deposits to total assets, financial expenses to total loans Inflation and reserve required ratio Bank size, interest margin, monetary policy interest rate and interest rate on interbank return on assets, inflation rate, growth rate of gross domestic product, public deficit and financial crisis Gross rate of GDP Tier 1 Capital and Impaired Loans Interbank funding, Growth rate of GDP and Inflation rate Bank size Non-performing loans, interest rate on interbank inflation rate, business cycle and financial crisis on liquidity return on equity, equity to total assets and unemployment rate
15. Factors Affecting Liquidity of Islamic Banks …….., Diyaeldin A. Abdelmagid 21 However, there has been relatively little literature published on factors affecting the liquidity of Islamic banks. Ramzan and Zafar (2014) studied a sample of 5 Islamic banks of Pakistan from 2007 to 2011. They suggested that only the asset size of the bank is directly associated with liquidity and has a positive and significant relationship with it. Thus, a strong asset base of Islamic banks helps to strengthen liquidity position. In contrast, capital adequacy ratio, networking capital, and profitability have insignificant correlated with liquidity. Investigating 18 banks in Iran over the period 2000-2013, Raeisi, et al. (2016) found that capital adequacy, bank stability, interbank funds, income to cost ratio, demanding deposits and savings, interest rates, number of internal branches and inflation are positive and significant correlated with liquidity. However, Asset quality and unemployment rate are negative and significant associated with liquidity. Abdillah, et al. (2016) investigated Islamic banks' profitability and liquidity in Indonesia for the period 2009- 2014. They highlighted a positive and significant impact of Capital adequacy ratio on the liquidity of Islamic banks. Besides, Non- performing financing has an insignificant effect. The study found that the ratio of Operating Expenses to Operating Income has a negative and significant influence on liquidity. Yaacob, et al. (2016) studied the determinants of liquidity risk of a sample of 17 Islamic banks in Malaysia over the period 2000-2013. This study demonstrated a positive and significant correlation between
16. 22 Banking & Financial Studies Issue No. 36 : July 2020 Capital adequacy and the inflation rate on liquidity risk. In contrast, profitability has an insignificant relationship with liquidity risk. They highlighted a negative and significant impact of financing and gross domestic product on the liquidity risk of Islamic banks. Comparing 196 Islamic and conventional bank from 20 countries over the period 2007-2013, Gafrej and Abbes (2017) found a positive and significant influence of past liquidity, return on assets and capital to total assets ratio on Islamic banks’ liquidity. In addition, they found a negative and significant influence of size to Islamic banks’ liquidity. On the other hand, for conventional banks they found a positive and significant influence of past liquidity and return on assets on conventional banks’ liquidity and a negative and significant influence of capital to total assets ratio, growth loans, size, age and inflation rate on conventional banks’ liquidity. The deposit interest rate and growth of gross domestic product have insignificant impact on liquidity. Dabiri et al. (2019) investigated the macroeconomic and banklevel determinants of liquidity of a sample of 14 Islamic banks in Malaysia for the period 2000- 2014. It was found that in the short-run capital adequacy and bank size has no significant while performance affects liquidity and in the long-run cost of capital and price level are found to have a negative and significant effect on liquidity in Islamic banks in Malaysia. 2.4 Islamic banks in Saudi Arabia: The Saudi banking sector consists of 12 local banks. There are two banking models in the Saudi Arabian banking industry: Islamic or
17. Factors Affecting Liquidity of Islamic Banks …….., Diyaeldin A. Abdelmagid 23 Shari'ah Compliant Banks and Banks with Mixed Operations. There are only four Islamic banks: Al Rajhi Bank, Bank AlBilad, Bank AlJazira, and Alinma bank. These banks represent that all their operations are conducted with Shari'ah Compliant. Bank AlRajhi, established in1957, is the oldest and largest Islamic bank in terms of assets. The second oldest bank is AlJazira, established in 1975. While AlBilad and AlInma banks were established in 2004 and 2007, respectively. (Lone, F. A., & Alshehri, S. 2015) Banks with Mixed Operations are conventional banks in their nature; however, they provide Islamic banking services through Islamic Branches or Windows. Islamic and mixed operations banks operate side by side under a single regulatory authority, the Saudi Arabian Monetary Authority (SAMA. (Khan, M. N., et al, 2018). Table 2 shows the Saudi Islamic Banks and network of branches as on (2017). Table 2: Saudi Islamic Banks Establishment and Branches Name Date of Establishment Branches Al Rajhi Bank 1957 539 Bank AlJazira 1975 80 Bank AlBilad 2004 114 Alinma bank 2007 76 Source: SAMA, 2018
18. Banking & Financial Studies Issue No. 36 : July 2020 24 Despite the small numbers, as compared to mixed operations banks, Saudi Islamic banks capture 51.3% of the total assets of the banking sector. (Khan, M. N., et al, 2018). 3. Data and Methodology: 3.1 Data: This study aims to investigate factors affecting the liquidity of Islamic banks in Saudi Arabia. It presents an analysis of four Islamic banks operating in Saudi Arabia during the period (2007– 2017). In gathering data, the study used the annual reports of these banks, their websites, and related web pages of the Saudi Arabian Monetary Agency (SAMA) on the internet. Based on the literature review, the study selected some significant variables that were expected to have a significant influence on the liquidity of Islamic banks. The summary of variables is given in Table 3. 3.2 Variables: Extracting from past literature on determinants of bank liquidity, Liquidity of Islamic banks is influenced by internal and external factors. Internal factors include bank-specific determinant of liquidity, whereas external factors include economic determinants that are not under control of bank management. Internal factors are divided into the following variables: profitability, bank size, capital adequacy, and deposits. While external factors divided into the following variables: macroeconomics, monetary policy, and crisis. Each variable has one or more indicators. Ratios that are taken into consideration return on
19. Factors Affecting Liquidity of Islamic Banks …….., Diyaeldin A. Abdelmagid 25 assets return on equity, total assets, capital adequacy ratio, deposits ratio, inflation, gross domestic products, unemployment rate, profit margin rate, interbank rate, and international crisis. Table 3 explains the various factors affecting Islamic banks’ liquidity. Table 3: Factors Affecting Islamic Banks Liquidity Factors Variables Size Ratios Return on Assets Return on Equity Total Assets Capital Adequacy Capital Adequacy Ratio Deposits Deposits Ratio Profitability Internal Factors Macroeconomics Inflation Gross Domestic Product Unemployment Rate External Factors Monetary Policy Profit Margin Rate Interbank Rate Crisis International Crisis Proxy Net profit to total assets Net profit to total equity Logarithm of total assets Capital adequacy ratio Tier I Total deposits to total assets Consumer price index Annual GDP growth rate Annual unemployment rate Murabaha Profit margin rate Libor rate Dummy variable for International financial crisis 2008 Islamic banks liquidity was measured using ratios of liquid assets to total assets (L1) and liquid assets to deposits and short term funding (L2). For the purpose of study, L1 and L2 are taken as dependent variables and rest of the variables, i.e., profitability, bank size, capital adequacy, deposits, macroeconomics, monetary policy and crisis have been considered as independent variables. 3.3 Hypothesis: Based on the literature reviewed, this study has the following hypothesis:
20. 26 Banking & Financial Studies Issue No. 36 : July 2020 3.3.1 Internal factors hypotheses: H1: Bank profitability has no significant impact on Islamic banks’ liquidity. H2: Bank size has no significant impact on Islamic banks’ liquidity. H3: Bank capital adequacy has no significant impact on Islamic banks’ liquidity. H4: Bank deposits have no significant impact on Islamic banks’ liquidity. 3.3.2 External factors hypotheses: H5: Macroeconomics has no significant impact on Islamic banks’ liquidity. H6: Monetary policy has no significant impact on Islamic banks’ liquidity. H7: International crisis has no significant impact on Islamic banks’ liquidity. 3.4 Methodology: This study investigates how the internal factors (return on equity, return on assets, size, capital adequacy, and deposits), and external factors (GDP, unemployment, inflation, murabaha profit margin rate, and crisis), affect the liquidity of Islamic banks in Saudi Arabia. It carried out both fixed and random effect regression to identify factors that affecting liquidity of Islamic banks in Saudi Arabia. Hausman test was applied to choose the appropriate test between fixed and random regression.
21. Factors Affecting Liquidity of Islamic Banks …….., Diyaeldin A. Abdelmagid 27 The following regression model was used to determine the relationship between liquidity level and its determinants: