Understanding the Relationship Between Liquidity and Banking Financial Stability in Islamic and Conventional Banks

Abstract

This article delves into the intricate relationship between liquidity and banking financial stability spanning from 2014 to 2021. Through rigorous empirical analysis, the study uncovers compelling evidence of bidirectional causality between liquidity and banking financial stability across the global panel, as well as within both Islamic and conventional banks. This nuanced understanding sheds light on the intricate dynamics at play within the banking sector, particularly regarding the interplay between liquidity levels and financial stability. One noteworthy finding is the presence of bidirectional causality, suggesting that liquidity and banking financial stability mutually influence each other. This implies that banks are not only affected by liquidity conditions but also play an active role in shaping their own stability through liquidity management strategies. Understanding this dual relationship is crucial for policymakers and regulators tasked with safeguarding the stability of the banking system. The implications of these empirical insights are far-reaching, particularly for regulatory authorities seeking to enhance the resilience of banks in the face of financial turmoil. By recognizing the significant impact of liquidity on banking stability, regulators can devise more effective measures to mitigate risks on bank balance sheets and promote greater liquidity management practices. Furthermore, facilitating the liquidation of assets during times of crisis can bolster the overall resilience of the banking sector, enabling banks to navigate turbulent economic conditions more effectively. This study offers valuable insights into the intricate interplay between liquidity and banking financial stability. By shedding light on the bidirectional causality between these two factors, the research provides a deeper understanding of the factors influencing the stability of the banking sector. Ultimately, these findings can inform regulatory efforts aimed at fortifying the resilience of banks and preserving financial stability in an increasingly complex and interconnected global financial landscape.