Liquidity Risk and Asset Quality; Financing in Islamic Banking: Canonical Correlation Analysis Approach

One of the most important risks that the Islamic banking system, the same as conventional banking, faces is liquidity risk. The liquidity management in the Islamic banking system, however, is more complicated compared to conventional banking because of difference in the nature of the tools used there and the forbiddance of riba  . The aim of this study is to investigate the relationship between the qualities of assets - debts and ways of financing with liquidity risk in Islamic banking, and also to examine this issue by considering the role of time element in liquidity risk, by dividing liquidity needs into 2 categories, urgent and non-urgent, using financial ratios. To achieve this we gathered the data for 67 Islamic banks from ORBIS and Banker database during the 2016-2011. The method used to investigate the subject was Canonical correlation analysis approach. The results gained by Stata software indicate that the liquidity risk is highly correlated with the quality of assets and financing. They also show whenever we use three urgent and non-urgent risk measures simultaneously, 97% of variability of liquidity risk is explained by the variability of independent variables (i.e. quality of asset - financing) but when we use urgent and non-urgent risk ratios independently, the amount of variability of dependent variable is explained by the variability of independent variables (i.e. quality of asset -financing) at 0/531 and 0/382 respectively.