Profit Sharing Investment Accounts: Implications for Liquidity Management

One of the distinguishing elements between Islamic and conventional banking in practices is the profit-sharing nature of Islamic banks. Unlike conventional banks that pay a certain fixed interest rate on their deposits, Islamic banks mainly employ a profit-sharing method between themselves and their depositors because the Islamic law prohibits the charging or collection of interest (Riba). Given this unique difference, it is widely accepted that the operations, management, and risk exposures of Islamic banks may vary considerably to conventional banks. One of such variations may be in their liquidity risk exposure and its management. Liquidity is crucial to the survival of any business venture, even more so for banks because they act as the main distribution channel of liquidity within an economy.
This research is therefore focused on understanding the possible implications of this unique profit-sharing accounts in Islamic banks on the management of liquidity and its risk exposure. In fulfilling this objective, the research studied the nature of deposits in Islamic banks and analysed the size and maturity of profit-sharing deposits in 14 sample Islamic banks. The research also looked at the different forms of liquidity and liquidity risk and challenges Islamic banks face in managing liquidity risk. In addition to this, a comparison was made between liquidity measurement and management frameworks of BCBS and IFSB. Overall, the outcomes of this research indicate that certain factors like undetermined return on profit sharing deposits, lack of deposit guarantee and behavioral attitude of profit-sharing depositors may influence the management of liquidity in Islamic banks. The results also show that majority of deposits in most Islamic banks are profit sharing based, this implies that Islamic banks need to be prudent in managing such funds in order to monitor cash inflows and outflows. This research should contribute to the extant literature on liquidity management in Islamic banks and highlight the importance of effective management of PSIA funds to avoid liquidity management crisis in Islamic banks.