Relationship between capital, risk and liquidity: a comparative study between Islamic and conventional banks in MENA region

The aim of this paper is to investigate the determinants and the joint relationship between capital, risk and liquidity of conventional and Islamic banks. Particularly, we focus on the impact of financial and political instabilities on the risk-taking behavior of conventional and Islamic banks. Using the simultaneous equation model with partial adjustment, we find a positive bidirectional relationship between capital and risk of Islamic banks. Moreover, results highlight the risky aspect of this category of banks mainly caused by the type of contracts put in practice, obeying Sharia principles, such as Moudharaba and Moucharaka contracts. Also, changes in liquidity affect positively risk within Islamic and conventional banks, suggesting that both types of banks, by accumulating liquid assets; tend to have relatively riskier portfolios. Moreover, we find a significant impact of the Global financial crisis on the capital, risk and liquidity of conventional and Islamic banks.