Literature Review

Carey (2001) investigated that risk management is additional significant for

financial or transitional institutions like banks as the essential objectives of these
institutions are to optimize the customers revenues and to improve optimality of
the shareholders wealth by eliminating the various nature of financial services.
In the pivotal work Keynes (1936) proposed the investors liquidity demand
motives appropriate to the monitory policy. Bruinshoofd and Kool (2004)
accelerate this work up and practical these motives (transnational, speculative and
precautionary) to examine the firm height determinants consists of information
asymmetries, chance cost along with transaction cost. In further advancement these
determinants furthermore became the element of cash administration models of
Baumol-Tobin (Baumol, 1952; Tobin, 1956; Miller and Orr, 1966).
Oldfield and Santomero (1997) directed that the establishment of reports and
standards, the development of self-investments strategies and plans, the structure
of salary and enticement contracts and the promise of rules and position edges are
four risk organization technique set up in financial institutions.
Salas and Saurina (2002) investigated the micro and macro level determinants of
credit risk of Spanish savings and commercial banks for the years of 1985-1997.
They planned that branch expansionGDP growth rate and inefficiency, capital ratio
and net interest edge and size were significant determinants of credit risk in
Spanish banks.Khambata and Bagdi (2003) explored the off balance sheet credit
risk of twenty banks of japanese. The results indicated that Japanese banks used
fewer OBS instruments, more risk opposed and customary than USA and European
banks.
Linbo Fan (2004) had deliberate risk of competence in national banks of USA and
directed that profit efficiency has reasonably a high relationship with insolvency
and credit risk while the liquidity riskis useless to contribute in profit efficiency of
USA national banks.

Ho Hahm (2004) investigated the manipulate of exchange rate and interest rate
exposure on Korean commercial and merchant banks in pre crises phase. The
results showed that the risk in concentration and exchange rate was moving the
Korean commercial banks.
Niinimaki (2004) explained the effect of struggle on banks risk and he found that
degree of risk depends on side and structure of the market in which opposition
takes place.
Wetmore (2004) look into the relationship between loan- to-core put down ratio
and liquidity risk of commercial banks. He accomplished that loan-to-core deposit
ratio increased with the modify in liquidity ratio.
In (2007), Al-Tamimi and Al-Mazrooei did not only determine the risk of
management techniques and practices of UAE banks but also contrast these follow
and techniques between the home and overseas banks of UAE. 45 closed-ended
Questions was developed to determine the degree of different types of risks and
findings reported that UAE commercial banks were somewhat efficient in risk
recognition, danger appraisal and risk managing but faced operating, credit and
foreign trade risk. In addition, both national and foreign banks used diverse
techniques to control, assess and watch the danger.
Isshaq and Bokpin (2009) examined about the determinants of commercial
liquidity supervision of listed companies of Ghana Stock Exchange above the stage
of 1991 to 2007. This study explained the panel model to examine the relationship.
The outcome show that networking assets, size of the firm, return on assets and
intention liquidity level are important determinates of liquidity supervision of
listed firms of Ghana.
In (2010), Ismal construct LRM index (100 scales) move in the direction of to
measure the liquidity risk supervision practice in Indonesian Islamic banks for the
phase of eight years from 2000 to 2007. The results indicate that LRM index
awards the good grade for organization the liquidity risk in Indonesian Islamic
banks. In Pakistan, little work has been done related to the collision of macro and
micro variables on risk management practices of Islamic banks of Pakistan. But, to
the best of my knowledge, no single study has alert on determinants of liquidity
risk of Islamic banks of Pakistan. Therefore, the present study investigates the firm

point determinants of liquidity risk of Islamic banks of Pakistan in excess of the

period of four years from 2006 to 2009.
Schroeck (2002) emphasized that the majorand main worth of good risks
supervision practices to optimize the firms value. He considered the risk of
liquidity of the firms effected by the different factors and had found significant
results.
A number of studies have been completed to estimate the link between good risk
management practices in accord of improved financial performances. In addition,
these studies suggest that cautious risk management practices moderate the
instability in banks financial performance, known as operating income earnings
firm of the market value share return and return on equity (Smith, 1995).
Schroeck (2002) intends that certifying best practices during prudent risk
management result in increased earnings.There are limited studies providing
observed evidence to the relationship between risk management practices and bank
financial performance.
The study by Drzik (2005) shows that bank investment in risk management during
1990s helped reduces earnings and loss unpredictability during the 2001 downturn.
In the similar element, the study by Pagach and Warr (2009) examine factors that
manipulate the firm level of enterprise risk management and finds that the
additional leveraged the firms are, the more unstable are their earnings.
Angbazo (1997) offers another element of analyzing the relationship between risk
management and financial performance by testing the influence of risk factors in
decisive banks profitability.
In particular, the study finds that non-payment risk is a determinant of banks net
interest margin (NIM) and the NIM of super provincial banks and provincial banks
are insightful to interest rate risk as well as default risk.
The study of Saunders and Schumacher (2000) provide additional support to the
importance of scheming risks to financial performance. By investigate the
determinants of NIM for 614 banks of 6 European countries and US from 1988 to

1995, the study finds that interest rate instability has a positive momentous impact
on the banks productivity.
Hakim and Neamie (2001) inspect the association among credit risk and banks
performance of Egypt and Lebanon bank in 1990s. The findings show that credit
unpredictable is positively related to profitability and liquidity variable is
unimportant across all banks and have no impact on profitability.
To approximation loss rates and calculating quality of portfolio, a simple statistical
tool by means of risk index was urbanized for risk measurement (Smith,
"Measuring Risk on Consumer Installment Credit", 1964).
Modigliani and Pogue (1974) presented two determine of risk; relative measure
denote by beta and measure of total risk denote by standard deviation. Relying on
monthly rate of return among 1945 to 1970 they conventional beta measure to be
more significant for securities pricing and expected for great portfolios.
Doherty (1975) presented a model base on loss probabilities to show how the
compass and level of interdependence connecting remarkable ways of treating risk
rely on the masterpiece of quality in risk management.
Ratti (1980) found that dissimilarities in atmosphere can cause positive (negative)
income affect that show the way to smaller amount (extra) risk taking by banks.
Kim and Santomero (1988) found capital ratios ineffective mean to limit banks
insolvency risk.
Deakins and Hussain (1994) argued that method of risk judgment has very
important inferences for banker and business relationships and decorated on
investing both in time and possessions through risk evaluation process.
Metwally (1997) found that while financing loans interest-free banks depend
intensely on their equity, face extra complication, and disposed to be fairly extra
conventional in utilizing their loan able resources than conventional banks.
Clementi (2001) presented and summarize of the tendency in consolidation of the
market, prior to review present suggestions on new Basel deal and on the banks
capital sufficiency. The study highlighted the recurring difficulty of liquidity and
then obtainable some examination of fresh developments, principally in risk

transfer method. The study stressed that improvement must be handled with some
care, and found risk management as momentous goal of financial system.
Ghannadian and Goswami (2004) judge the appearance of an Islamic banks and
how Islamic banking plan can execute liquidity and maintain in the process of
money creation from side to side involvement dealings accounts and found that in
all increasing economies investing funds on basis of profits and losses is an
prominent choice for the banks.
Gabbi (2004) emphasized about the addiction of risks on organizations position in
the market. The study explain that liquidity risk can be controlled in the course of
practice that are strictly connected to the scale and scope of financial procedures
seeing as large banks are accomplished both to manage additional market
information and to authority monetary policy functions.
Zheng (2006) found that short-term capitulate spreads are under enemy control by
liquidity risk. Franck and Krausz (2007) found that securities market substance
more in supporting bank for likely liquidity insufficiency while studying the
function of stock exchange as a comparable function of and lender of last resort.
Many dealers thinks that additional liquid markets are better to fewer liquid
markets (Mainelli, 2008) and found exceptionality of liquid markets are elasticity
penetration and tightness.
Zheng and Shen (2008) stated that in the presence of liquidity risk more realistic
loss can be estimated by liquidity adjusted conditional value at risk which provides
a better measure for risk. And also suggested efficient Monte Carlo method: which
applies to portfolio of securities or single securities, and finds approximate
conditional value at risk and risk at value of all percentiles from the loss
distribution with in single set of samples.
Anas and Mounira (2008) suggests that Islamic banks should strengthen their risk
management practices such as, to enhance secondary market they need price
transparency and liquidity. Moreover, they can trade Sukuks and Financial Takaful
(insurance) as a medium of risk-hedging.
Hassan (2009) argues that three types of risks are being faced by Islamic banks in
Brunei Darussalam such as, credit risk, foreign-exchange risk and operating risk,

and they are managing those risks very efficiently with the help of risk
management practices, which includes risk identification (RI) and risk assessment
and analysis (RAA).
Dinger (2009) proposed that in emerging economies, due to the existence of
transnational banks aggregate liquidity shortage risk has been reduced, as in
normal circumstances they are holding low liquidity assets but in crises they holds
higher liquid assets as compared to single market banks.
Vaihekoskia (2009) investigated that in the period of systematic liquidity risk
(illiquidity) of those stocks which provides high rate of return were negatively
related to the price of liquidity risk. Therefore, systematic liquidity risk is not
priced as an asset-specific risk but as market-wide systematic risk as it is enough to
occupy all liquidity related risks.
Uddin (2009) identified that there exists the negative relationship between liquidity
and stock return, as stock become more illiquid the liquidity risk increases more
than the relative rate, also indicate that return is not affected by the fluctuations in
the relative stock liquidity.
Ismal (2010) indicate that with respect to liquidity management, the Islamic banks
in Indonesia are examined themselves on the basis of three factors such as banks
liquidity management policy, liability side and asset side, and they stand in the
index of good grade.
Ismal (2010) suggested that Islamic banks should improve their policies to balance
liability and asset, communicate their operations and principles to public to deepen
their understanding towards Islamic banks and restructure management of liquidity
on asset and liability side in order to improve and strengthen their liquidity
management.
Sawada (2010) investigated that in the times of crises, due to the liquidity shock
persuaded by the depositors, banks increase their cash holdings by selling their
securities in the financial market, not by liquidating their loans. As they adjust their
portfolio dynamically through selling and buying their securities in financial
market.

Ojo (2010) emphasis on the importance of risks all the way through a position to
the vital role which are engaged by capital adequacy. On the basis of Accord
principles thestudy observed that beside substantial development, a lot of work is
yet to be done especially relative to liquidity risk.

As banking institutions, Islamic banks also have to meet their liquidity needs and
obligations to ensure the smooth running of their business, as it is the case with
their conventional counterparts. However, the unique nature of Islamic banks with
their objective of avoiding riba (interest) in any form requires additional issues to
be addressed in order to meet their liquidity needs in a Shariah compliant manner.
Many have argued that liquidity risk is a major risk facing the Islamic banks (see,
for example, Ray, 1995). Apart from the financing nature of the Islamic banks
which rely on long-term equity contracts such as mudarabah and musharakah,
another reason for the potential liquidity problem in Islamic banks is due to the
limited number of financial instruments that are accepted by Shariah scholars.
As a result, Islamic banks do not have the same funding options that are available
to conventional banks in the interbank market. The absence of an adequate money
market or a secondary capital market for Islamic financial instruments complicates
the problem of mismatched maturities. Liquidity problems have also been
purported to be the major impediment to the growth of Islamic banking (Vogel and
Hayes, 1998).
Essentially, the liquidity risk in the Islamic banks arises from the lack of sufficient
Shariah-based liquid instruments. From the Shariah perspective, additional issues
arise in transforming the financial modes into negotiable financial instruments due
to the maxim that once a debt has been created, it cannot be transferred to other
parties except at par value.
On the other hand, depositor funds are either callable on demand or require very
short withdrawal notice periods. Thus, the possibility of the Islamic bank to
experience liquidity shortage is rather high in the event of a sudden rise in the
borrowers withdrawal of deposits.

In addition, the Islamic banks are prohibited by the Shariah from borrowing at
short notice by discounting debt obligation receivables (for example through a
central bank discount window). There is also no Shariah compliant lender of the
last resort facility offered by many central banks.
This means that Islamic banks are particularly exposed to liquidity risk because
they tie up their investment account holders funds in illiquid long term assets, such
as Ijarah assets, or mudarabah/musharakah profit-sharing arrangements. However,
Al-Sadah (1999) found in his study that several Islamic banks in Bahrain take into
consideration the level of liquidity on each type of account (investment, saving and
current accounts) to meet investors withdrawals. The level of liquidity is
influenced by the liquidity requirements imposed by the regulatory agencies on the
Islamic banks.
Kim and Santomero (1988) examined the responsibility of bank capital regulation
in controlling solvency risk. By employing mean-variance model, they found
capital ratios unproductive way to restrict banks insolvency risk (Bauer &Ryser,
2004) regulatory restrictions, debt ratio, volatility of risky assets, size of
liquidation costs and spread between deposit rate and riskless interest rate are the
significant constraints that compel banks hedging decisions.
Siddiqui (2008) found that Islamic banks in Pakistan were more liable towards
considering projects with long-term financing and better performance in terms of
assets and return established improved risk management with keeping safe
liquidity.
Sensarma and Jayadev (2009) investigated the risk management of public and
domestic private banks of India for the period 1998 to 2006. They found an
enhancement on risk management aptitude of the banks.
Akhtar et al., (2011) established better performance in elements of assets and
return which recognized that conventional banks had improved liquidity risk
management than Islamic banks in Pakistan.