Liquidity Risk Management in Islamic and Conventional Banking: A Comparative Study

Abstract

This study examines liquidity risk management in Islamic and conventional banking using a systematic literature review. Liquidity risk is a critical driver of bank soundness, as even solvent institutions can fail when they cannot meet short term obligations at reasonable cost. Post crisis reforms, especially Basel III through the Liquidity Coverage Ratio and Net Stable Funding Ratio, have reshaped banks’ liquidity positions and funding structures, creating a trade off between short term profitability and long term resilience. The review shows that Islamic banks face additional challenges due to Sharia compliant contracts, limited secondary markets, and underdeveloped Islamic interbank and lender of last resort facilities, making liquidity risk more sensitive to capital adequacy, asset quality, and balance sheet composition than in conventional banks. The findings highlight the central role of regulatory design and governance, including Sharīah governance, in shaping liquidity strategies and risk taking behavior. Overall, the evidence indicates that Islamic banks tend to hold higher liquidity buffers and adopt more conservative postures, suggesting that “one size fits all” regulation is suboptimal and that liquidity frameworks should be tailored to the distinct contractual structures, governance mechanisms, and market access conditions of Islamic and conventional banks.