Liquidity Crisis: Are Islamic Banking Institutions More Resilient?

The importance of liquidity risk and the threat of ensuing bank-run can hardly be overemphasized. The peculiar structure of Islamic banks and their call to the faith of the customers pose interesting questions regarding their behavior during a liquidity crisis and calls for detailed empirical study. Using a natural experiment of an episode of liquidity crunch in Pakistan during 2008, we attempt to decipher the differential behavior of Islamic and conventional banking institutions during such episodes. Our results show that, Islamic banking branches are less prone to the risk of withdrawal during the bouts of liquidity stress and this effect remains robust to the addition of an array of controls. The results suggest that, greater financial inclusion of faith based groups through Islamic banking, for example, may not only increase their economic well being but may also bring in stability in the financial system.