Financing Government Budget Deficit as a Liquidity Risk Mitigation Tool for Islamic Banks: A Dynamic Approach

Abstract

The article deals with the issue of liquidity management for Islamic banks. Based on data extracted form Bankscope, it is shown that Islamic banks suffer from excess liquidity. This liquidity can not be invested using conventional means because of Shari’ah considerations. In the other hand, almost all OIC member countries run with budget deficit and huge amounts of debt. The main contribution of this paper is to introduce a framework constituting a linkage between Islamic banks funding capacity and Governments financing needs; using money market approach. Later on, the volatility of existing sovereign Sukuk is compared to corporate Sukuk, using GARCH (1, 1) model, to assess the stability of the secondary market for Islamic government securities.

Keywords: Islamic banks, liquidity risk management, budget deficit financing, volatility

JEL Classification: G21, G32, H6