How to explain the liquidity risk by the dynamics of discretionary loan loss provisions and non-performing loans? The impact of the global crisis

Abstract

Purpose

The purpose of this paper is to investigate the impact of discretionary loan loss provisions (DLLPs) and non-performing loans (NPLs) on the liquidity risk of both Islamic banks (IBs) and conventional banks (CBs) before and after the global crisis that hit nations belonging to the Gulf Cooperation Council (GCC).

Design/methodology/approach

This empirical study uses balanced panel data on 16 IBs and 58 CBs operating in the six Gulf Cooperation states covering 2000–2014. The data were obtained from the Bankscope database and the banks’ annual reports.

Findings

The results indicate that NPLs affect liquidity risk differently across the banks – specifically, there is a significant difference in the funding and managing of liquidity between the two bank types. The authors find that the influence of DLLPs does not vary across the banks in the overall analysis and before the crisis. This finding provides insights into the unique nature of banking risks in dual banking systems. The authors also find that after the crisis, the discretionary LLPs affected liquidity risk differently across the banks.

Practical implications

This study has several practical implications. First, the findings suggest that the Islamic Financial Services Board and other IBs regulators should reassess several regulations, principles and products in order to reduce their credit and liquidity risks. Second, the study emphasizes the need for banks to perform a careful assessment of the effects of their LLP policies. Finally, the findings are also relevant to bankers, as they provide empirical evidence on the effect of loan growth on bank liquidity, suggesting that bankers should improve their loan management.

Originality/value

First, this is the first study to examine discretionary LLPs, NPLs and liquidity risk in IBs; it is also the first comparative study between Islamic and CBs. Second, the study provides evidence on how the global crisis impacted the banking sector and identifies some of the main determinants of liquidity risk for both Islamic and CBs operating in GCC countries.

Citation

Riahi, Y.M. (2019), "How to explain the liquidity risk by the dynamics of discretionary loan loss provisions and non-performing loans? The impact of the global crisis", Managerial Finance, Vol. 45 No. 2, pp. 244-262. https://doi.org/10.1108/MF-12-2017-0520