Liquidity creation by Islamic and conventional banks during the Covid-19 pandemic

Abstract

This study investigates how liquidity has been created during the Covid-19 pandemic and examines the different behaviours to create liquidity for different types of bank ownership. Monthly panel data of 85 Indonesian Islamic and conventional banks are utilized to capture the time periods before and during the pandemic. The estimated regression model applies one period lag for all independent variables to reduce any endogeneity problems. The results indicate that overall banks created less liquidity during the pandemic. This finding implies that adding assets is not an effective strategy to create liquidity since banks transferred assets into safer investments during the pandemic. However, Islamic banks created more liquidity, especially when off-balance sheet activities are not included in the liquidity measurement. This phenomenon validates the unique market structure of Islamic banks, which must comply with Sharia law and avoid holding and trading prohibited assets. On the liability side, the deposits of these banks will be more liquid due to their depositors' religiosity and risk preferences. This study further indicates that the government-owned bank generated more liquidity than other ownership types. These results imply that the government successfully rescued the economy during the pandemic through the use of economic stimuli.

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