Equity-Based Financing and Liquidity Risk: Insights from Malaysia and Indonesia
Keywords:Liquidity risk, Equity-based financing, Islamic banks, Profit-loss sharing, Pass-through mechanism
This study examines the effect of equity-based financing (EBF) on Islamic bank liquidity risk (LR) in Malaysia and Indonesia. The EBF-LR relationship is compared using the traditional and BASEL III liquidity measures. The results provide little evidence that EBF increases banks’ LR using the Net Stable Funding Ratio (NSFR). The higher the EBF, the higher the required stable funding; hence, lower NSFR sequentially raise the LR, supporting the maturity transformation hypothesis. EBF may increase exposure to LR if Islamic banks often use short-term deposits to fund long-term financing. However, EBF does not have a significant influence on the traditional LR measure, suggesting the pass-through mechanism exists, implying that investment account holders absorb the losses in cases of default. This study offers empirical evidence of the pass-through mechanism of profit loss-sharing in Islamic banks using the traditional measure besides supporting the maturity transformation hypothesis using the BASEL III liquidity risk measure.
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